A key measure of prices closely monitored by the Federal Reserve suggests that inflation pressures in the U.S. economy are continuing to ease. This development is significant as it impacts the Fed’s future decisions on interest rates.
Latest Data on Consumer Prices
The Commerce Department’s report on Friday revealed that consumer prices remained flat from April to May, marking the mildest such performance in over four years. On a year-over-year basis, prices rose 2.6% last month, slightly less than in April. Excluding volatile food and energy prices, core inflation increased by 0.1% from April to May, which is the smallest rise since the spring of 2020 when the pandemic initially caused economic disruptions. Compared to a year earlier, core prices were up 2.6% in May, the lowest increase in over three years.
Breakdown of Price Changes
Prices for physical goods, such as appliances and furniture, actually fell by 0.4% from April to May. Meanwhile, prices for services, including items like restaurant meals and airline fares, ticked up by 0.2%. These figures indicate a varied impact of inflation across different sectors, with goods experiencing a slight deflation and services seeing modest price increases.
Implications for Federal Reserve Policy
The latest figures are likely to be well-received by the Fed’s policymakers, who have stated that they need to be confident that inflation is sustainably slowing toward their 2% target before considering interest rate cuts. Most economists anticipate that the Fed could start reducing rates as early as September if the current trend continues. Olu Sonola, head of U.S. economic research at Fitch Ratings, noted, “If the trend we saw this month continues consistently for another two months, the Fed may finally have the confidence necessary for a rate cut in September.”
Historical Context and Recent Trends
The Fed raised its benchmark rate 11 times during 2022 and 2023 to combat the worst streak of inflation in four decades. Although inflation has cooled substantially from its peak in 2022, average prices remain significantly higher than pre-pandemic levels. This persistent inflation is a source of frustration for many Americans and poses a potential threat to President Joe Biden’s re-election bid. However, Friday’s data provides further evidence that inflation pressures are easing, albeit more slowly than last year.
The Fed’s Preferred Inflation Gauge
The Fed favors the personal consumption expenditures price index (PCE), which was released on Friday, over the better-known consumer price index (CPI). The PCE index attempts to account for changes in consumer behavior in response to inflation, such as switching from expensive national brands to cheaper store brands. Like the PCE index, the latest CPI also showed that inflation eased in May for the second consecutive month, reinforcing hopes that the early-year price acceleration has passed.
Economic Growth Amid High Borrowing Costs
Contrary to widespread expectations that the high borrowing costs following the Fed’s rate hikes would tip the nation into recession, the economy has continued to grow, and employers have maintained hiring. Recently, however, the economy’s momentum appears to have slowed, with higher rates affecting consumer spending. The government reported that the economy expanded at a 1.4% annual pace from January through March, the slowest quarterly growth since 2022. Consumer spending, which drives the economy, grew at a modest 1.5% annual rate during this period.
Positive Signs in Consumer Spending and Income
Despite the slowdown, Friday’s report also showed encouraging signs for the economy, with both consumer spending and incomes picking up in May. Adjusted for inflation, consumer spending rose 0.3% last month after a 0.1% decline in April. Additionally, after-tax income, adjusted for inflation, saw a 0.5% increase, the biggest gain since September 2020.
Conclusion
The recent data on consumer prices and spending provides a cautiously optimistic outlook for the U.S. economy. While inflation pressures appear to be easing, the Federal Reserve will need to see consistent trends before making decisions on interest rate cuts. The upcoming months will be crucial in determining whether the current trend continues, potentially leading to lower borrowing costs and further economic stabilization.
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