The Federal Reserve's preferred inflation gauge accelerated in May, with the Personal Consumption Expenditures (PCE) price index rising 4.1% from a year earlier, its highest annual rate in three years.
Consumer spending and personal income both increased 0.7% during the month, suggesting households continue to spend despite higher prices.
The combination of stronger inflation and resilient consumer demand is likely to reinforce expectations that the Fed will keep interest rates elevated — or even consider additional rate hikes.
There’s growing evidence that inflationary pressures are building in the economy. The Federal Reserve's preferred measure of inflation accelerated in May, providing fresh evidence that the U.S. economy remains surprisingly resilient even as higher prices continue to challenge policymakers.
The Commerce Department reported this week that the Personal Consumption Expenditures (PCE) price index rose 0.4% in May from the previous month and 4.1% from a year earlier, up from 3.8% in April. Excluding the volatile food and energy categories, the core PCE price index increased 0.3% during the month and 3.4% over the past year.
That number is important because the PCE index is closely watched, and is the inflation measure the Federal Reserve relies on most heavily when setting monetary policy. The central bank has a long-term inflation target of 2%, which suggests it won’t cut interest rates anytime soon.
However, consumers are still spending
The inflation report was accompanied by signs that consumers remain willing to spend despite higher borrowing costs and elevated prices.
Personal income rose by 0.7% in May, while disposable personal income also increased 0.7%. Consumer spending climbed 0.7%, or $156.1 billion, with gains in both goods and services. After adjusting for inflation, real consumer spending increased 0.3%.
The increase in spending was led by services such as healthcare, housing and utilities, transportation, and financial services, while purchases of goods also rose, according to the Bureau of Economic Analysis. Farm income and higher employee compensation contributed to the increase in personal income.
Mixed bag
In short, the report paints a mixed picture of the economy.
On one hand, rising incomes and continued consumer spending suggest households remain financially resilient, helping to support economic growth. Consumer spending accounts for roughly two-thirds of U.S. economic activity, making it a key driver of the nation's economy.
On the other hand, the acceleration in inflation complicates the Federal Reserve's efforts to return price growth to its 2% goal. Economists noted that higher energy prices, along with continued increases in healthcare, transportation, and financial services costs, contributed to May's inflation pickup.
The stronger-than-expected economic backdrop has prompted investors to reassess the outlook for interest rates. Earlier expectations that the Fed might lower rates this year have faded as inflation has remained stubbornly above target while consumer demand continues to hold up.