US PCE In July Higher Than Expected At 3.7%, But Core PCE Matches Forecast

• PCE inflation rose 0.2% in July and 3.7% annually, both above expectations.

• Core PCE increased 0.2% monthly and 3.3% annually, matching forecasts.

• Markets see only about a one-in-three chance of a September rate hike.

US consumer prices rose slightly in July, with the Federal Reserve’s preferred inflation gauge showing that price pressures remain elevated as policymakers weigh the next move on interest rates.

The personal consumption expenditures price index increased 0.2% on a seasonally adjusted monthly basis, while the annual inflation rate reached 3.7%, according to the Commerce Department.

Both readings were 0.1 percentage point above the Dow Jones consensus.

The data suggest that inflation has not continued its recent moderation at the pace policymakers would like, potentially complicating the Federal Reserve’s debate over whether interest rates should remain restrictive or be raised further.

The PCE index measures prices paid by US consumers for a broad range of goods and services.

It also accounts for changes in consumer spending patterns, making it the Fed’s preferred gauge for assessing inflation.

However, the more closely watched core PCE index, which excludes volatile food and energy prices, provided a less concerning picture.

Core PCE rose 0.2% in July and 3.3% from a year earlier, matching economists’ expectations.

The core measure is generally considered a better indicator of underlying and longer-term inflation trends.

Services continue to drive prices

Goods prices actually declined 0.1% during July, helped by a 2.7% drop in gasoline and other energy-related goods.

Prices for furnishings and long-lasting household equipment fell 0.9%.

Services, however, continued to put upward pressure on inflation.

Prices for services rose 0.3%, including a 1.2% increase in financial services and insurance and a 0.3% rise in housing costs.

The report also showed that personal income increased by 0.4%, while consumer spending rose by 0.2%.

Both measures were stronger than expected, suggesting that household finances and demand remain relatively resilient despite elevated prices.

A separate government report showed that US gross domestic product grew at an annualized 1.5% pace in the second quarter, in line with expectations.

September rate hike bets fall

Financial markets have recently reduced expectations for a September rate increase.

The probability of at least a 25-basis-point hike in September has fallen to 36% from around 67% earlier this month, according to CME Group’s FedWatch Tool.

Investors still expect interest rates to be higher by the end of the year, but the latest inflation data are unlikely to provide a clear signal for the Fed’s next meeting.

The 3.7% headline PCE reading remains significantly above the central bank’s 2% inflation target.

However, the core PCE reading came in exactly as expected, making the 3.3% annual and 0.2% monthly readings the key figures for policymakers.

The recent slowdown in inflation has strengthened the case among Federal Open Market Committee members who voted to leave rates unchanged in July at 3.50% to 3.75%, where they have remained since December.

At the same time, inflation has remained above the Fed’s target since February 2021.

A growing minority of officials believe additional restraint could be required to ensure inflation returns sustainably to 2%.

The FOMC will next meet on Sept. 15-16.

Markets currently see only about a one-in-three probability of a move at that meeting, with December viewed as the more likely window for a potential rate increase.

Treasury yields remain elevated

The inflation data also come as government bond yields have climbed sharply.

Yields on 10-year and 30-year Treasury securities recently reached their highest levels since 2007.

Investors have expressed concerns about the Fed’s ability to bring inflation back to target, while growing US debt and budget deficits have also contributed to upward pressure on long-term yields.

Stock futures pulled back slightly after the inflation report, while Treasury yields moved higher.

Treasury Secretary Scott Bessent recently announced plans for the department to increase its buybacks of government debt.

However, market participants have questioned whether the initiative will have a meaningful impact on Treasury yields.

Fed officials are also gathering this week in Jackson Hole, Wyoming, for the central bank’s annual symposium.

The event will be closely watched for clues about the direction of monetary policy, with Chairman Kevin Warsh scheduled to deliver a policy speech on Friday.

Since taking office in May, Warsh has remained cautious about signaling his preferred path for interest rates, instead allowing incoming economic data and financial markets to shape expectations.

For now, the July inflation report leaves the Fed facing a difficult balance: core inflation is behaving broadly as expected, but headline inflation remains well above target, and the pace of improvement remains slow.