5-Month High! Fed’s Preferred Inflation Gauge Heats Up – How It Affects Rate Cut Prospects

Data released on Friday showed U.S. inflationary pressures rose slightly in July. Meanwhile, consumer spending saw its largest increase in four months.

With the Fed’s September policy meeting approaching, institutions widely believe that, given the backdrop of a softening labor market, relatively controllable price pressures may not be enough to alter the consensus on restarting rate cuts. However, the path toward further easing remains uncertain.

Price Pressures Rise Further

The Bureau of Economic Analysis (BEA) stated that the Personal Consumption Expenditures (PCE) Price Index increased by 0.2% month-on-month in July, slowing by 0.1 percentage points from the previous month, mainly due to a 1.7% decline in gasoline and other energy goods costs. Year-on-year, it grew by 2.6%, unchanged from June.

Excluding volatile food and energy, the core PCE Price Index rose by 0.3% month-on-month, meeting expectations, while year-on-year growth accelerated to 2.9%, the highest level since February. The core PCE is the Fed’s preferred inflation parameter and a key predictor of future inflation.

Within this, service costs increased by 0.3% month-on-month and rose by 3.4% year-on-year, hitting a nearly one-year high, driven by a 1.2% increase in financial services and insurance prices. This is a more concerning sign, as inflation in the services sector has remained persistently high over the past few years, and these prices are less affected by tariffs. If services inflation remains elevated and tariffs further push up goods prices, broader inflation could worsen.

Consumer spending, which accounts for over two-thirds of economic activity, accelerated to 0.5% in July after an upward revision to 0.4% in June, marking the highest level since March this year. The acceleration in spending was largely due to goods purchases, which rose by 0.8% month-on-month, particularly durable goods such as cars, household furniture, and sports equipment. Services spending increased by 0.4%, while expenditures at restaurants, bars, hotels, and motel rooms declined.

Low unemployment supports robust growth in consumption and wages. Wages increased by 0.6% month-on-month in July. However, due to rising operational costs from tariffs, employers are reluctant to increase hiring. The government reported this month that after significant downward revisions to May-June data, employment growth averaged 35,000 per month over the past three months through July, far below the 123,000 recorded in the same period of 2024.