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The Fed’s preferred measure of inflation shows signs of cooling

by Lily Chang
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The Federal Reserve’s preferred measure of inflation continues to show signs of cooling, accompanied by moderate growth in consumer spending – welcome news for central bankers aiming to control rising prices and curb demand.

In May, the personal consumption expenditures (PCE) index rose 2.6% from a year earlier, meeting economists’ expectations and down slightly from April’s 2.7% increase. Excluding the more volatile food and fuel prices, core inflation also rose 2.6% year-over-year, down from April’s 2.8%. On a monthly basis, inflation remained remarkably subdued, with overall prices not showing any significant increases.

The Federal Reserve is likely to be looking closely at this new inflation data as it considers its next policy moves. Since 2022, the Fed has been aggressively raising interest rates to suppress consumer and business demand, which can help slow price increases. However, since July 2023, borrowing costs have held steady at 5.3% as inflation has gradually moderated. The Fed is now deliberating on the timing of potential interest rate cuts.

While officials initially expected to implement several rate cuts in 2024, these plans were delayed due to persistent inflation earlier in the year. Policymakers still expect one or two rate cuts before the end of the year, with investors speculating that the first cut could occur in September. However, this decision will depend on upcoming economic data, including inflation and labor market metrics.

While inflation has remained above the Fed’s 2% annual target, it has slowed significantly from its peak in 2022, when overall PCE inflation reached 7.1%. The consumer price index (CPI), a related measure, hit an even higher peak of 9.1% and has declined substantially since then.

Fed officials have indicated that rate cuts will begin once they are confident that inflation is under control or if the labor market unexpectedly weakens. While policymakers generally expect inflation to slow in the coming months, some are concerned about potential stagnation.

“Much of the gains in inflation last year were driven by supply-side improvements, including loosening supply chain constraints, greater availability of workers partly driven by immigration, and lower energy prices,” Fed Chair Michelle Bowman said in a speech this week. She warned that these factors could be less favorable going forward.

Conversely, other officials worry that a broader economic slowdown could soon have repercussions on the labor market, fearing that keeping interest rates high for too long could excessively dampen growth and hurt American workers.

Hiring has remained robust, and while wage growth is cooling, it remains strong. However, some indicators suggest that working conditions are weakening: job openings have fallen sharply, the unemployment rate has risen, and jobless claims have risen slightly.

“The labor market has been slow to adjust, and the unemployment rate has increased only slightly,” noted Mary C. Daly, President of the Federal Reserve Bank of San Francisco, in a recent speech. “But we are approaching a point where this benign outcome may be less likely.”

The report released Friday found that consumer spending remained moderate in May, further evidence that the economy is losing momentum.

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