Fed’s Preferred Inflation Gauge Shows Underlying Price Pressures Rising

Federal Reserve Board Chairman Jerome Powell looks on during a news conference following the announcement that the Federal Reserve raised interest rates by half a percentage point, at the Federal Reserve Building in Washington, on Dec. 14, 2022. Evelyn Hockstein/Reuters

A key inflation gauge closely tracked by the Federal Reserve showed that underlying price pressures increased in December while consumer spending declined, suggesting that inflationary pressures could take longer to dissipate and that the economy faces headwinds as shoppers retrench.

Government data released on Jan. 27 by the Department of Commerce showed that the so-called core Personal Consumption Expenditures (PCE) index rose 0.3 percent in December, a faster pace of price growth than the rate of 0.2 percent in November.

In year-over-year terms, core PCE slowed its pace in December, rising 4.4 percent compared to 4.7 percent in November.

The core PCE inflation measure, which excludes the volatile categories of food and energy, is the measure that the Fed relies on heavily when assessing inflation because excluding short-term price fluctuations from the overall inflation measure gives a clearer picture of underlying inflationary trends.

The picture is somewhat mixed, however, given that the year-over-year data show a decline in core inflation while the month-over-month data show underlying inflationary pressures accelerating. Still, the 4.4 percent pace of annualized core PCE is over twice the Fed’s inflation target of 2 percent.

The headline PCE inflation measure, which includes food and energy, rose by 0.1 percent in December, matching November’s pace, while the year-over-year rate declined from 5.5 percent to 5.0 percent.

More Upside for Inflation?

Many analysts saw Friday’s data as a sign that inflation was easing overall, but some noted that the Fed’s fight to quash price pressures isn’t yet over as underlying inflation could see more upside in coming months.

“Overall, inflation is moderating. But it is likely to be faster over the next few months than the last few,” said Jason Furman, a Harvard economist and Obama-era economic adviser, in a post on Twitter. “And most underlying measures are still well above the Fed’s target. More work to do!”

Faced with high inflation, the Fed has raised rates aggressively, delivering the fastest pace of rate hikes since the 1980s.

Some economists, however, have called for the Fed to slow down on its path of monetary tightening or risk driving the economy into a contraction.

“While inflation is still well above target and unemployment is at a cycle low, there are signs that the economy is responding to tighter monetary policy and the Fed will be cognizant of fears that hiking rates too hard and fast risks toppling the economy into recession,” ING analysts said in a note.

ING analysts predict that the Fed will hike rates by 25 basis points at its upcoming policy meeting of the Federal Open Market Committee on Jan. 31–Feb. 1. They also believe that inflation will fall sharply through the second and third quarters and that core PCE will be in a range of 2.0–2.5 percent by the end of 2023.

Consumer Spending Slumps

The Commerce Department report also showed that consumer spending—which accounts for around two-thirds of GDP and so is a key driver of the U.S. economy—fell 0.2 percent last month.

Consumer spending data for November was also revised downward to show a 0.1 percent contraction rather than 0.2 percent growth as previously reported. The spending figures in the last two months of the 2022 were the weakest in two years.

“Consumer spending slowed sharply through the fourth quarter, and we will need to see a rapid turnaround to prevent a contraction in the first quarter of this year,” ING analysts wrote in a note.

Friday’s report from the Commerce Department also showed the smallest gain in personal income in eight months in December, which is not a good sign for consumer spending in the months ahead.

“The Fed needs to tread cautiously here with the economic outlook starting to darken,” said Christopher Rupkey, chief economist at FWDBONDS in New York. “Policymakers are closer to the end than the beginning in their inflation fight.”

A separate government report released Thursday showed that personal disposable income fell by more than $1 trillion in 2022, a decline of 6.4 percent compared to the prior year. This marks the sharpest decline in the measure since the Great Depression, when disposable personal income plunged 13.1 percent in 1932.

Reuters contributed to this report.