A primary gauge of inflation saw its first monthly decline in six years, accompanied by slower-than-expected economic growth, potentially offering the Federal Reserve room to hold interest rates steady. However, recent geopolitical developments and underlying economic data suggest that further rate hikes remain a possibility.
The Personal Consumption Expenditures (PCE) price index rose 3.7% in June over the prior 12 months, a decrease from the 4.1% recorded in May, according to the Bureau of Economic Analysis. The core PCE index, which excludes volatile food and energy prices and is closely watched by the Fed, increased by 3.3% on an annualized basis, a slight 0.1% rise from the previous month.
The decline in the headline PCE figure was largely attributed to a 9% drop in energy and gasoline prices in June. This decrease followed a temporary ceasefire agreement between the U.S. and Iran. However, that agreement has since collapsed, with the U.S. launching retaliatory strikes against Iran following attacks on U.S. forces in Jordan. Escalating tensions in the Middle East have led to a resurgence in national average gasoline prices, now exceeding $4 a gallon, and concerns about disruptions to maritime trade routes in the Red Sea, which could impact global energy supplies.
Market experts suggest that this single report is unlikely to deter the Federal Reserve, especially given recent statements from Fed Chair Kevin Warsh emphasizing the need for sustained inflation reduction. Warsh indicated that one good inflation reading would not alter the course of monetary policy, particularly as some Federal Reserve officials voted for a rate increase. A sustained downward trend in inflation is needed to convince policymakers, and elevated oil prices due to Middle East tensions could hinder this.
Consequently, a September rate hike remains a plausible option, which would likely keep borrowing costs for consumers, such as credit card debt and loans, elevated.
Economic Growth and Consumer Spending
Separately, the Bureau of Economic Analysis reported that U.S. economic growth, as measured by Gross Domestic Product (GDP), expanded at an annualized rate of 1.5% in the second quarter. This figure fell short of economists' estimates of 1.8% growth.
Federal Reserve officials are navigating the dual risks of tightening monetary policy too aggressively, which could stifle economic growth, or waiting too long and allowing inflation to accelerate. The softer GDP reading provides some argument for a pause in rate hikes. Nevertheless, the data was influenced by temporary factors, including the conflict in Iran, higher oil prices, and tariffs imposed by the Trump administration.
Underlying strengths were evident in the report, particularly in consumer spending, which increased at a robust 3.2% annual rate in the second quarter, a significant improvement from the 0.5% pace in the first quarter. In June alone, inflation-adjusted consumer spending rose by 0.4% month-over-month. Business investment also demonstrated strength, growing by 15% in the second quarter, driven in part by substantial spending by technology companies on memory chips and data center infrastructure.