In June, U.S. inflation showed signs of cooling as the cost of goods declined, offsetting a rise in the cost of services. This trend, highlighted by a report from the Commerce Department, suggests a more favorable inflation environment that could allow the Federal Reserve to begin cutting interest rates as early as September.
Moderation in Inflation
The personal consumption expenditures (PCE) price index, a key measure tracked by the Federal Reserve, edged up by 0.1% in June, following a flat reading in May. This moderate increase aligns with economists' expectations and reflects a balance between falling goods prices and rising service costs. Specifically, goods prices dropped by 0.2%, driven by decreases in motor vehicles, parts, and furnishings. Conversely, the cost of services rose by 0.2%, mirroring May's gain, with housing and utilities costs advancing slightly.
In the 12 months through June, the PCE price index increased by 2.5%, marking the smallest year-on-year gain in four months. Excluding volatile food and energy components, core PCE inflation rose by 0.2% in June. This consistency in core inflation, alongside recent upward revisions, indicates a stable inflation trend.
Implications for Federal Reserve Policy
The recent easing of price pressures and a cooling labor market boost the confidence of Federal Reserve officials that inflation is moving toward their 2% target. Olu Sonola, head of U.S. economic research at Fitch Ratings, remarked, "The key question now is whether the positive momentum we've seen over the last three months will be disrupted heading into the September meeting." This suggests that the upcoming policy meeting on July 30-31 will be crucial in setting the stage for potential rate cuts.
Kathy Bostjancic, chief economist at Nationwide, noted, "The much-improved inflation readings indicate that the flare-up in inflation in the first quarter was temporary." This sentiment reflects the Fed's perspective that recent inflationary pressures are transitory and manageable.
Consumer Spending and Income Growth
Consumer spending, which accounts for over two-thirds of U.S. economic activity, increased by 0.3% in June, slightly down from an upwardly revised 0.4% gain in May. This spending growth was primarily driven by a 0.4% rise in services, including housing, utilities, financial services, insurance, healthcare, and international travel. However, goods outlays only ticked up by 0.1%, partly due to disruptions from a cyberattack at software systems provider CDK.
Personal income rose by 0.2% in June, following a 0.4% increase in May. However, the growth in disposable income after adjusting for inflation and taxes was modest at 0.1%. This slower income growth, coupled with a loosening labor market, suggests that consumer spending will likely remain moderate in the coming months. Despite this moderation, the pace of spending is expected to be sufficient to sustain economic growth.
Financial Market Expectations
The Federal Reserve has maintained its benchmark overnight interest rate in the 5.25%-5.50% range since last July, following a series of rate hikes totaling 525 basis points since 2022. With inflation subsiding and labor market conditions easing, financial markets anticipate up to three rate cuts this year, beginning in September.
Bank of America Securities economists estimate that excess savings accumulated during the COVID-19 pandemic stand at around $400 billion, projected to last through the end of the year at the current pace of depletion. Veronica Clark, an economist at Citigroup, observed, "Rising savings had suggested consumers were pulling back on spending and saving more for possibly precautionary reasons."
Conclusion
As the U.S. inflation landscape continues to improve, the Federal Reserve appears poised to consider interest rate cuts in September. The moderation in inflation, coupled with steady consumer spending and income growth, provides a stable foundation for the economy. The upcoming Fed policy meeting will be closely watched as officials assess whether the current positive momentum can be sustained, setting the stage for potential rate cuts that could further bolster economic growth.