PCE Inflation Showing Few Signs Of Moderating

Scott Anderson
Chief Economist
Bank of the West

The personal income and spending report for September from the Bureau of Economic Analysis showed continued solid gains in nominal consumer spending and income but more worrisome inflation data for the Fed as it tries to lower stubbornly-high inflation.

Nominal personal income rose a solid 0.4% last month – in-line with the consensus forecast and unchanged from August – as the tight U.S. labor market compels employers to increase wages to attract and retain workers. Inflation, however, continues to wear down the purchasing power of consumers as inflation-adjusted personal income was flat in September after rising meager 0.1% in August. Real personal income has declined for nine consecutive months year-on-year. The unwind of COVID income supports combined with high inflation has been a toxic mix for real personal incomes, although the 1.0% decrease last month was the smallest drop since February.

Real Personal Income Declined Again In September
Still the continued erosion of purchasing power amid high inflation and other headwinds have not yet deterred the U.S. consumer from spending. Real personal spending climbed 0.3% in September, in-line with the consensus estimate. The gain was driven entirely by a 0.6% increase in services spending. Goods spending dipped 0.1% – the third consecutive monthly decline – suggesting consumers are shifting their limited dollars to services and away from goods. Despite the solid monthly increase, growth in real consumer spending from a year ago slowed slightly to 1.9%, but has been relatively steady in recent months despite aggressive Fed interest rate hikes.

Real Personal Spending Growth Moderated Slightly
The report also contained some troubling data in the nation’s inflation problem. The PCE core deflator – which excludes volatile food and energy prices and is the Fed’s preferred measure of inflation – climbed 0.5% in September. This was on par with the August reading and still above the average monthly gain of 0.4% this year. Core PCE inflation was 5.1% from a year ago last month and has accelerated for the last two months. This nearly ensures another aggressive 75 basis point rate hike from the Fed at the November FOMC meeting next week.

Core Inflation Has Accelerated For Two Straight Months
Persistently high inflation, continued aggressive interest rate hikes from the Fed and slower job and income growth will likely weigh on the consumers’ ability and desire to spend next year. Real consumer spending growth peaked in the second quarter at a 2.0% pace as consumers ventured out and travelled extensively for the first time since that pandemic began. But by early next year, nearly two years of negative real disposable income growth, net job losses, and depleted savings are expected to take their toll on the consumer. The U.S. economy appears most vulnerable to a recession sometime in the first half of next year with the Fed expected to boost interest rates into early next year, thereby increasing the risk of overtightening into a slowing or already contracting economy.

Consumer Spending Growth To Slow Sharply In Q4
Dampening U.S. consumer and global demand will eventually slow inflation. We are forecasting Core PCE inflation will gradually moderate through 2024 and approach the Fed’s 2.0% target in the second half of 2024. This should allow the Fed to lower rates a bit in 2024 allowing an economic recovery to take hold.

To learn more, check out this week's U.S. Outlook Report.


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