Despite a sharp drop in energy prices, August’s personal consumption expenditures price index—the Federal Reserve’s key gauge for inflation—rose by 0.3% after falling by 0.1% in July.
The price increases ate into spending, bringing spending growth from a 0.4% increase in dollar terms to only a 0.1% gain on inflation-adjusted terms.
July’s real spending number was revised down from a 0.2% increase to a 0.1% decline, according to data released on Friday by the Bureau of Economic Analysis.
The increase in inflation was driven by core inflation, which increased by 0.6% on the month, and by 4.9% on a year-ago basis—too high for the Fed to reconsider its policy path.
We expect that the Fed will have to raise interest rates higher than the annualized core PCE inflation number, which means a policy rate of between 4.75% and 5% early next year, with the chance that rates could go even higher. That implies more rate hikes coming in the first quarter of next year.
The slowdown in spending was most likely a result of the Fed’s campaign against inflation. But the impact of monetary policy tightening won’t be completely felt by consumers this year.
The persistently tight labor market helped disposable income grow in back-to-back months, rising by 0.4% on nominal terms and 0.1% on inflation-adjusted, providing American consumers some needed buffer.
At the same time, consumers have reached into their savings accounts in the past couple of months to keep up with their spending costs. August’s savings rate was 3.5%, significantly lower than the pre-pandemic average of 7.4%.
There remained $1.9 trillion of excess savings waiting to be spent. Without a substantial catalyst, spending growth might stay afloat in the last half of the year.
August’s spending continued to shift from goods to services. Goods spending dropped by 0.2% while services rose by 0.2% on real terms.
Still, there is more room for services to grow as spending on services remained below the trend line. Transportation services increased by a sharp 1.75% on the month as summer travels peaked and energy prices fell. Spending on gasoline and other energy goods was also up significantly at 2.1%.
On the other hand, an imminent recession coupled with rising interest rates will further slow down goods spending, likely bringing it back to the pre-pandemic trend.
Except for motor vehicles and gasoline, spending on all goods categories dropped on the month, led by furniture and recreational goods.
As the Fed continues its rate increases to tame inflation, the labor market is facing a significant contraction and the loss of millions of jobs. That should happen next year, when the job market feels the impact of restrictive monetary policies.