A customer shops in a Lowe's home improvement store on August 20 in Los Angeles.
CNN —
The Federal Reserve’s go-to inflation gauge held at 2.5% in July, Commerce Department data showed Friday. That’s better than anticipated and shows progress — but still underscores the bumpy process for inflation’s descent.
Friday’s report also reaffirmed that the backbone of the US economy — the consumer — is still holding strong, although their piggy banks are getting lighter.
Spending was up by 0.5%, or 0.4% when adjusted for inflation, landing above expectations for the month when car dealerships were back in gear after a massive software outage in June and when Amazon puts on its annual Prime Day sales event.
The Personal Consumption Expenditures price index, which the Fed uses for its 2% target rate, was 2.5% for the year ended in July, unchanged from June. On a monthly basis, prices increased 0.2% versus 0.1% the prior month.
The latest inflation reading, which served as further confirmation that the pace of price hikes is sustainably cooling, comes just weeks before the Fed is expected to start easing monetary policy and cutting interest rates.
“I thought the report was right down the strike zone,” Mark Zandi, chief economist at Moody’s Analytics, told CNN in an interview Friday. “Bottom line, it indicates that inflation continues to moderate and is within spitting distance of the [Fed’s] target.”
The core PCE index, a closely watched measure of underlying inflation that strips out the more volatile components of food and energy, held steady as well by rising 0.2% for the month and 2.6% annually.
Green light for a rate cut
The biggest reason why inflation is not yet at 2% is housing services, particularly the implicit cost of homeownership, Zandi said. Rental and housing inflation has cooled substantially in the market but is measured with a lag in PCE and other inflation gauges, such as the Consumer Price Index.
For all intents and purposes, the Fed has achieved its inflation goals, Zandi said.
“We’re there, and it’s a bright green light for them to start easing interest rates,” he said.
Economists had fully anticipated the index would move higher due to “base effects,” because July’s data would be compared with a year-ago period that showed faster-than-usual disinflation. Consensus expectations were for PCE to rise by 0.2% for the month and 2.6% for the year.
Even though the annual rates held unchanged from what was seen in June, the progress is apparent, said Gus Faucher, senior vice president and chief economist at PNC Financial Services Group. Core inflation, he noted, is running at an annualized rate of about 1.7%.
“Inflation continues to head in the right direction and, at the same time, incomes are rising and consumer spending is going up,” he told CNN in an interview. “So, a solid report that supports a Fed rate cut at the September [monetary policy] meeting and then additional rate cuts through the rest of this year and into 2025.”
Faucher and PNC, similar to other economists and market projections, expect the Fed will ratchet down its benchmark rate by a quarter point at the September 17-18 meeting. The Fed very well could make similarly sized reductions at its November and December meetings, he said.
“The economy is still in decent shape,” Faucher said, noting the expectations for a quarter-point cut. “If they were to cut by [a half point], that would be a signal that something’s wrong with the economy and might cause some panic.”
The first rate cut would serve as a major milestone for Americans who have been weighed down by fast-rising prices for three and a half years and squeezed by high interest rates (the Fed’s antidote to inflation) for two years running. Inflation and its effect on Americans have been highlighted as key priorities for both presidential candidates.
Drawing down the savings
With inflation practically tamed, the once-strong labor market has now become the unruly elephant in the room contributing to uncertainty.
“Success on inflation is just one side of the equation, and one-half of the Fed’s mandate,” Elizabeth Renter, senior economist at NerdWallet, wrote in commentary issued Friday. “Now, they’re focused on whether disinflation will be accompanied with little-to-no disruption in the labor market.”
A weaker-than-expected jobs report in July spooked markets, but nerves have settled as measurements of layoff activity have remained stable. A trove of new jobs data comes out next week, and the seminal August employment report is expected to show a return to modest, but still-strong, job growth of 175,000 positions.
A job market staying on stable footing has helped keep Americans’ earnings running above inflation for more than a year. That has contributed to continued spending which, in turn, has kept fueling the economy.
Earlier this month, the Commerce Department reported that retail spending surged 1% in July after falling 0.2% the month before, trouncing expectations in the process. Friday’s more comprehensive read on spending also bested expectations (for a 0.3% gain) and showed that consumers are shelling out for goods (particularly motor vehicles) in addition to services.
But it comes at a cost.
Spending growth continued to outpace overall and disposable income gains, which were both up 0.3%. As such, the personal saving rate (the percentage of disposable income that’s socked away) dipped to 2.9%, the lowest since June 2022.
“That’s not sustainable,” Faucher said. “What we’re going to need to see is consumer spending growth slow to below income growth, but we don’t need to see outright declines in spending.”
