Core inflation hits 2% on 3-month basis as consumer spending surges to year-high

The Federal Reserve's preferred inflation measure came in cooler than expected in August, and a sweeping annual revision to government data has quietly rewritten the recent inflation story — bringing the three-month annualized rate of core price growth all the way down to 2%, exactly the Fed's target, even as Americans spent at the fastest pace in more than a year.

The core Personal Consumption Expenditures (PCE) price index — which strips out volatile food and energy costs — rose 0.2% from July, below the 0.3% economists had forecast, according to data released Wednesday by the Bureau of Economic Analysis. On an annual basis, core PCE held at 3.0%, well below the 3.3% consensus estimate. Headline PCE, which includes food and energy, rose 0.3% for the month and 3.4% year-over-year — unchanged from the prior month after that figure was itself revised down from 3.7%.

The softer readings were partly the product of methodological changes the Commerce Department made to three key categories: portfolio management and investment advice services, legal services, and computer software and accessories. As previously measured, portfolio management fees tended to rise and fall with stock prices; the new approach more accurately reflects actual pricing shifts, according to the BEA. The revisions reach back to January 2021, and their effect was significant: July's core PCE annual rate was revised down from 3.3% to 3.0%, and the headline annual rate fell from 3.7% to 3.4%.

I think the inflation momentum doesn't look quite so scary after this report, perhaps.— Oliver Allen, Senior US Economist, Pantheon Macroeconomics

Allen noted to CNN that the three-month average of annualized changes in core PCE stood at 2% in August, versus a 3.1% rate implied by the pre-revision data — a meaningful shift in how policymakers can read the trajectory of price pressures.

The cooler inflation print lends support to New York Fed President John Williams, who said the day before the release that there is no immediate urgency for another rate hike, according to ING. Markets moved quickly: pricing for a rate increase at the October Fed meeting dropped from 18 basis points to 9 basis points, while cumulative pricing for the December meeting fell from 39 basis points to 29 basis points, per ING.

Both headline and core PCE remain above the Fed's 2% annual target. The Fed raised its benchmark interest rate for the first time in three years earlier this month, according to CNN.

The main driver of monthly inflation was energy. Gasoline prices rose 4.4% in August, and transportation services climbed 1.4%, according to CNBC TV18 — reflecting the ripple effects of an energy shock tied to the war in Iran, as CNN reported.

Against that backdrop, American consumers kept spending. Current-dollar personal consumption expenditures jumped 0.9% in August — slightly above the 0.8% forecast — with $114.1 billion of the $190.8 billion increase coming from goods and $76.7 billion from services, per the BEA. Adjusted for inflation, real spending rose 0.6%, the strongest monthly gain in more than a year, according to CNN.

The spending strength came at a cost to household finances. Personal income grew just 0.2% in August, below the 0.4% expected, and real disposable income was flat after adjusting for inflation. As a result, the personal saving rate dropped half a percentage point to 4.1% — a nearly four-year low, according to the BEA and CNN.

Households pinched by higher prices have been either reducing their monthly savings rate or relying more on credit.— Kathy Bostjancic, Chief Economist, Nationwide

For the last couple of years, we've seen spending grow faster than incomes – that's unsustainable over the longer run.— Gus Faucher, Senior Vice President and Chief Economist, The PNC Financial Services Group

Faucher told CNN that a lot of the excess spending has been driven by high-income households supported by a strong stock market, a source of demand he cautioned cannot be counted on indefinitely. The trajectory of income growth, he said, suggests the current pace of consumer spending is likely to slow, though remain fairly solid.

The same annual revision that reshaped the inflation picture also upgraded the broader economic story. The BEA revised its estimate of second-quarter GDP growth to a 2.2% annualized rate, up from the prior estimate of 1.5%. Consumer spending — which accounts for roughly 70% of US economic activity — grew at a 3.8% annualized pace in the second quarter, sharply higher than the 0.7% pace recorded in the first quarter, according to CNBC TV18. Business investment excluding housing rose at a 9% annualized pace, helped by continued investment linked to artificial intelligence. Imports jumped at a 12.6% annualized rate, partly because of increased shipments of computer chips and other AI-related products, which reduced second-quarter GDP growth by nearly 1.7 percentage points. Residential investment rose 2.8%, its first increase since the end of 2024 despite elevated mortgage rates.

ING noted that the revisions to household income data are particularly significant: under the old methodology, real household disposable income had flat-lined for 18 months. The revised data show it has been trending higher, albeit weakly — suggesting that middle- and lower-income households, who depend more heavily on income than financial assets for spending power, have been under less financial pressure than previously feared.

The next major data point arrives Friday, when the monthly jobs report is due. Economists are expecting the US economy added 94,000 jobs in September, with the unemployment rate holding at 4.1%, according to CNN. The BEA's first estimate of third-quarter GDP growth is scheduled for October 29.

Why it matters — The data give the Fed its clearest signal yet that inflation is tracking back toward its 2% target, reducing pressure for further rate hikes — but the gap between what Americans earn and what they spend is widening, and savings are near a multi-year low, raising questions about how long the consumer-driven growth can last.

Reported by reuters.com, bea.gov, bloomberg.com, bls.gov, cnn.com, cnbctv18.com, bostonherald.com, think.ing.com