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

The Fed’s preferred measure of inflation shows signs of cooling
The Fed’s preferred measure of inflation shows signs of cooling
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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 – positive 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, in line with economists’ expectations and down slightly from April’s 2.7% increase. Excluding more volatile food and fuel prices, the measure of “core” inflation also rose 2.6% year-on-year, down from 2.8% in April. On a monthly basis, inflation remained particularly moderate, with overall prices showing no 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 remains above the Fed’s annual target of 2%, it has slowed significantly from its 2022 peak, when headline PCE inflation hit 7.1%. The related measure, the consumer price index (CPI), peaked even higher at 9.1% and has since fallen substantially.

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

“Much of the progress on inflation last year was due to supply-side improvements, including easing supply chain constraints, greater availability of workers partly due to immigration, and energy prices lower,” said Michelle Bowman, Fed governor, in a speech this week. She warned that these factors could be less favorable in the future.

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 a weakening of working conditions: job vacancies have fallen sharply, the unemployment rate has increased and jobless claims have increased slightly.

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

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

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