PCE inflation report: Key measure ticks higher in July. What will the Fed do?

An inflation measure that’s watched closely by the Federal Reserve edged higher in July, possibility raising the chances that the Federal Reserve will raise interest rates again this year.

Consumer prices increased 3.3% from a year earlier, above the 3% pace in June but below the 40-year high of 7% in June 2022, the Commerce Department said Thursday.

Much of the July rise was due to the fact that inflation already had started to slow somewhat by July 2022 and so the gap in prices between that month and July 2023 was larger.

On a monthly basis, prices rose 0.2%, in line with June’s increase,  according to the personal consumption expenditures (PCE) price index.

July’s uptick, however, was sharper before the figures were rounded.

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Meanwhile, consumer spending accelerated in a development that could maintain upward pressure on prices.

What is core PCE inflation?

An inflation measure that excludes volatile food and energy items also climbed 0.2%, similar to June. That nudged the annual increase in so-called core prices to 4.2% from 4.1% the previous month.

Broadly, the report reveals a slightly bigger monthly pickup in inflation than the consumer price index released earlier this month. Both reports show a decline in the price of goods, such as used cars, as pandemic-related supply chain troubles have resolved.

But prices of services such as health care, financial advice, transportation and insurance advanced more dramatically in Thursday’s report. That’s partly because those services are weighted more heavily in the PCE than the CPI index and higher wholesale costs play a bigger role, Barclays wrote in a research note.

What is supercore inflation?

Fed Chair Jerome Powell has said officials are most concerned about stubborn inflation for such services. They exclude volatile food, energy and housing and their costs are tied closely to fast-rising employee wages. Prices of those so-called “supercore” services jumped 0.5% in July after an upwardly revised 0.3% bump the previous month. .

That may boost the odds of another rate hike because the Fed traditionally has focused more intently on PCE than CPI inflation.

“We remain skeptical that inflation is on track to return to its 2% target without a significant easing of labor market conditions,” Barclays wrote in a research note. The firm predicts another quarter point rate increase in November while Nationwide economist Ben Ayers thinks the Fed could lift rates again in September.

A report Friday is expected to show that U.S. employers added 168,000 jobs in July, a significant slowdown from earlier this year, but the unemployment stayed near a half-century low at 3.5%.

What is the current Fed interest rate?

Pantheon Macroeconomics, however, reckons the Fed will hold its key rate steady the rest of the year after raising it by 5.25 percentage points in 16 months – the most aggressive flurry of rate increases in four decades. The rate is at a range of 5.25% to 5.5%, highest in 22 years.

Household spending, meanwhile, surged 0.8% in July, boosted partly by Amazon Prime Day sales, following an upwardly revised 0.6% rise in June. Incomes rose 0.2%, slightly less than expected. Generally, incomes have outpaced inflation in recent months but that trend appeared to stall in July, giving consumers a bit less purchasing power.

Yet the robust increase in spending could push prices higher and, along with a sturdy economy, help lead the Fed to raise interest rates again this year.

Consumption, though, could slow this fall as many Americans resume student loan repayments that were suspended by COVID relief legislation. Households are also edging closer to depleting their $2,6 trillion in federal stimulus checks and other pandemic-related savings.

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