The Fed’s preferred inflation measure remains stubbornly high

The Personal Consumption Expenditures inflation measure, which is the measure the Fed officially targets as it tries to achieve 2% annual inflation, climbed 6.2% over the year through August. While that was a slowdown from 6.4% in July, it was higher than the 6% economists in a Bloomberg survey had expected.

The details of the report were even more concerning. Price increases have been moderating somewhat on an overall basis, partly because gas prices have been declining. But after volatile fuel and food prices were stripped out to get a sense of underlying inflationary pressures, the index climbed 4.9% over the year through August, an acceleration from 4.7% the month before. And on a monthly basis, the core index picked up by 0.6%, the fastest increase since June.

Consumers also continued to spend in August, particularly on dining, travel and other services, the report showed, though the pace was slowing. Incomes rose, buoyed by a hot job market.

The data underlined the challenging path the Fed faces as it tries to guide the U.S. economy toward slower inflation. Both the economy and price pressures have retained momentum, even as central bankers raise interest rates to try to cool demand. As a result, the Fed has become steadily more aggressive in its efforts to constrain spending and temper inflation, and it is likely to keep raising rates and keep them elevated for a while.

“Inflation is very high in the United States and abroad, and the risk of additional inflationary shocks cannot be ruled out,” Lael Brainard, the Fed’s vice chair, said in a speech Friday. She later added that policymakers were “committed to avoiding pulling back prematurely.”

The Fed has lifted interest rates five times this year, including three unusually large three-quarter-point increases, and Brainard reiterated that it would need to restrict the economy for some time to make sure inflation was back under control. But she also emphasized that future rate increases would depend on incoming data, suggesting that the Fed will keep an eye on the economy as it slows down and calibrate its moves accordingly.

Economists remain hopeful that healing supply chains, a slowing housing market, cooling consumer demand and a moderating labor market will combine to pull inflation lower in the months ahead. Spending on goods fell in August for the second month in a row, which should ease pressure on factories and shipping routes, and overall spending may slow further as consumers draw down the extra savings they built up earlier in the pandemic.

But Russia’s war in Ukraine poses a constant risk to the global supply of food and oil, and some industries, including automobiles, remain severely disrupted. Rents and other service costs have been rising sharply, and labor shortages spanning many industries have pushed wages up, which could feed through to higher prices.

Those factors have informed the Fed’s decision to stage its most aggressive campaign in decades to bring inflation under control.

Fed officials signaled in their latest economic projections that they expect to lift interest rates by another 1.25 percentage points by the end of the year. The report probably keeps them on track for such a plan, said Subadra Rajappa, head of U.S. rates strategy at Société Générale.

The above-expectation inflation number “has to be somewhat troubling, but I don’t think it changes anything for the Fed,” she said. “They have more work to do.”

Still, the Fed’s war on inflation comes at a risk. Higher interest rates take time to filter through the economy, and the Fed is moving so quickly in its bid to choke off inflation that it isn’t waiting to see the effect of its moves before ushering in new ones.

“They have to choose between being forward-looking versus backward-looking,” said Blerina Uruci, a markets economist at T. Rowe Price. She said that the fresh consumption data suggested that consumers were pulling back, but that is taking time to show up in inflation data — so by focusing on the price figures, the Fed could end up raising rates more than is needed.

And other central banks are also raising rates, which could combine with turmoil from the war in Ukraine and other factors to sharply slow the world’s economy. Fed officials have acknowledged that the global situation is in a state of flux.

“The Federal Reserve’s policy deliberations are informed by analysis of how U.S. developments may affect the global financial system and how foreign developments in turn affect the U.S. economic outlook and risks to the financial system,” Brainard said Friday.

As higher rates play through the economy to slow spending and weaken the labor market, they could push up unemployment and even cause a painful recession. While officials are hoping that outcome can be avoided, they admit that the chances of averting a bad outcome have grown slimmer, as inflation has remained persistently and painfully high and their policy path has become more aggressive.

Still, central bankers have suggested that it is a necessary gamble. While a recession would be bad for Americans, costing them jobs and most likely slowing their wage gains, today’s inflation is also a burden on many households. Families are finding that it is harder to afford basic necessities like housing, clothing and food, which is a particular burden for consumers with lower incomes who have less room to cut spending from their budgets or to substitute with cheaper options.