The Fed’s favored inflation gauge eases to slowest pace in more than two years

By Alicia Wallace, CNN

New York (CNN) — Rising prices continued to loom large in January, but new data released Thursday showed that inflation is still on a downward — albeit bumpy — path toward the Federal Reserve’s 2% target.

The Personal Consumption Expenditures price index was up 2.4% for the 12 months that ended in January, a slowdown from December’s 2.6% increase, according to Commerce Department data released Thursday. The closely watched core PCE index that excludes energy and food edged down to 2.8% from the 2.9% annual rate seen in December.

While the latest read on the Fed’s preferred inflation gauge showed progress toward the central bank’s target, Thursday’s data also highlighted the choppiness of this yearslong battle to rein in spiking prices: Prices rose in January from December at their fastest clip in months.

On a monthly basis, the PCE price index rose 0.3% and core jumped 0.4%. In December, both indexes rose 0.1%.

Economists had projected the PCE index would rise 0.3% for the month and 2.4% for the 12 months ended in January and for the core index to jump 0.4% for the month and cool to 2.8% annually, according to FactSet.

The core PCE index, which Fed officials view as a crucial gauge of underlying inflation, rose at the fastest monthly pace since February 2023.

Consumers cut back in January

Thursday’s Personal Income and Outlays report also showed that consumers held back on some purchases in January. Spending rose 0.2% for the month, a cooling from the 0.7% leap a month prior.

However, when taking the inflated prices out of the equation, “real” spending dipped by 0.1% for the month as they bought far fewer goods (especially fewer trucks) and pulled back on some services purchases.

During the month, goods spending fell 1.1% while services spending increased 0.4%, according to the Commerce Department.

Economists had expected spending to be flat, given the typical holiday spending hangover and the 0.8% drop recorded in January’s retail sales data.

Household finances got a big boost to start the new year: Personal income — which has a broad definition of income by individuals, nonprofits and trust funds and includes employer contributions to health and pension plans — surged by 1%, matching the gain seen in January 2023, which was the largest since July 2021, data shows.

After taking out taxes, disposable income grew 0.3%, and the savings rate inched up to 3.8% from 3.7% the month before.

“Consumer spending fell in January, the first drop since March 2023,” PNC chief economist Gus Faucher wrote Thursday. “Still, household spending rose sharply at the end of 2023, and consumers are generally in good shape thanks to the strong labor market, slowing inflation, and rising asset values (both homes and stocks).”

‘No reason for alarm’

Thursday’s PCE data closes out a month where January saw hotter-than-expected inflation from both the Consumer Price Index (retail-level price changes) and the Producer Price Index (wholesale level).

While economists and the Fed are quick to caution that “one month does not make a trend” and that January data typically carries a lot of noise, last month’s warmer inflation reports reinforce the central bank’s decision to not start cutting too early, said Christopher Clarke, an assistant professor of economics at Washington State University.

“It’s an uptick, that’s not a welcome thing,” Clarke told CNN. “There’s no reason for alarm at this point, but it’s certainly an unwelcome one-month figure.”

The December monthly gains were revised down from 0.2% to 0.1%, Clarke noted, adding that the longer-term trends remain in line with what the Fed wants to see.

A new year’s effect?

One element of concern for the Fed is the 0.6% monthly jump in the “super core” measure of core services less housing, Nationwide chief economist Kathy Bostjancic wrote in a note issued Thursday.

That, combined with the overall core increase, “justifies Fed officials’ less-dovish mood as of late,” she wrote.

The January bump in services inflation could be the result of a beginning of the year “price reset,” Victoria Clark, economist at Citigroup, told CNN earlier this week.

“We always used to see this happen — maybe more so in certain goods, where prices would come up with the new year,” she said.

This time around, it appears that it’s happening on the services front, she said, adding that it appears that those types of businesses are passing along higher labor costs.

Still, it’s also possible that because of those one-time price pops that January could be even more of an outlier, and that similarly strong inflation prints are not as likely going forward.

“I would be surprised if the strength of January does repeat,” she said. “But it’s telling us that there are these pressures still in the pipeline.”

Shelter’s heavy weight on inflation

Delivering a fair amount of pressure as of late, especially on the CPI, has been housing.

The PCE price index, which is considered one of the most comprehensive measures of the prices US households pay for goods and services, was widely expected to have a cooler inflation read than the popular CPI. A big reason for that: housing, specifically the way that shelter-related costs are factored into federal data.

The BLS’ shelter index is meant to capture changes in rents; “owners’ equivalent rent of residences,” which is an estimate of the implicit cost that owner-occupants would pay if they were renting their homes; as well as lodging away from home and household insurance.

Shelter is more heavily weighted in the tabulation of the overall CPI than it is in the PCE index; and during January, shelter costs accounted for two-thirds of the larger-than-expected 0.3% monthly gain in the CPI.

Market-rate rents have moderated, and economists have long expected that activity to be better reflected by lower shelter inflation in the CPI. Instead, shelter prices have remained high and continue to be a big driver of inflation.

And after the January CPI showed a bump in the owners’ equivalent rent index, economists attributed the bump to record-high home prices.

However, the January jump might have been the result of new weighting instituted by the Bureau of Labor Statistics, Bloomberg reported this week, citing an email from the Labor Department agency staff.

That weighting could result in that shelter component remaining high for the next five months, unless the BLS “comes up with clear reasons to think the January jump was a one-time fluke,” Ian Shepherdson, chief economist of Pantheon Economics, wrote Thursday.

“We see no reason, however, to change our big picture view that core inflation is falling and will continue to slide, thanks to the pass-through from slowing wage gains, improving supply chains, and margin re-compression,” Shepherdson wrote. “But the Fed is hyper-cautious after the ‘transitory’ fiasco, and a sustained run of relatively elevated core CPI/PCE prints … increases the chance that the first easing is delayed beyond our May forecast.”

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