The Fed’s preferred inflation measure shows signs of cooling

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 seeking to control rising prices and dampen demand.

The personal consumption expenditures (PCE) index rose 2.6% year-over-year in May, in line with economists’ expectations and down slightly from a 2.7% gain in April. Excluding the more volatile prices of food and fuel, the “core” inflation measure also rose 2.6% year-over-year, down from 2.8% in April. On a monthly basis, inflation remained remarkably subdued, with overall prices not showing any significant increase.

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 eased. The Fed is now deliberating on the timing of any interest rate cuts.

While officials initially planned 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 come 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 expressing concerns about potential stagnation.

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

Conversely, other officials worry that a broader economic slowdown could soon impact the labor market, fearing that keeping interest rates high for too long could dampen growth too much 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 unemployment 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.