July PCE Report: PCE Inflation Index Up 2.5%, Softer Than Expected

The July Personal Consumption Expenditures Price Index posted a softer increase than expected, up 2.5% from year-ago levels. Economists forecast the PCE index would rise 2.6%, and with a tame reading on inflation, the Federal Reserve is widely seen as being able to cut interest rates in September.

When volatile food and energy costs are factored out, the Fed’s preferred measure of inflation increased 2.6% from one year ago, below expectations of 2.7%.

The PCE Price Index increased 0.2% from month-ago levels. Excluding food and energy, the index also increased 0.2%.

Even as consumer spending remains strong, “inflation is nevertheless falling,” says Preston Caldwell, chief US economist at Morningstar. “With the mild numbers for July and some downward revisions to the second-quarter data, core PCE inflation has dropped to just a 1.7% annualized rate in the past three months.”

In addition, Caldwell notes that so-called “supercore” inflation (core services excluding housing) has fallen to a 2.1% annualized rate in the past three months after jumping to 5.5% in March, thanks largely to a rise in the financial services category.

July PCE Inflation Report Highlights

• The PCE Price Index rose 0.2% in July, in line with the FactSet consensus forecast and following an increase of 0.1% in June.
• Core PCE rose 0.2% in July, in line with forecasts and following an increase of the same amount in June.
• The PCE Price Index year over year rose 2.5% in July, below forecasts for a 2.6% increase and following an increase of the same amount in June.
• Core PCE year over year rose 2.6% in July, below forecasts for a 2.7% increase and following an increase of the same amount in June.

Caldwell says some components of the index won’t provide the kind of downward push on inflation seen in the past three months. “Airline prices were down 13% annualized, owing to lower jet fuel prices and strong competitive pressures, but that’s not going to repeat,” he says. “But we’re also seeing a broader lessening in inflation in services industries that can be sustained thanks to slowing wage growth, which had been running much higher than normal.”

Against the backdrop, the Fed will likely cut its target rate from its current range of 5.25%-5.50%; the question is by how much. “With inflation normalizing, there’s little reason to keep rates at highly restrictive levels, which risks triggering a recession,” Caldwell says. “On the other hand, today’s data on real consumption growth shows there’s no imminent emergency. There’s no need to deploy 50-basis-point-per-meeting rate cuts, as some have been betting. The rise in unemployment, while concerning, looks like an anomaly in the backdrop of otherwise strong economic data.”