The US personal consumption expenditures (PCE) price index, the Federal Reserve's preferred inflation gauge, rose 3.4% in May compared to a year earlier, marking the highest annual increase in three years. The data, released by the Bureau of Economic Analysis on Friday, exceeded economists' expectations of 3.3% and accelerated from 3.1% in April.
Core Inflation Remains Elevated
Excluding volatile food and energy prices, core PCE inflation also rose 3.4% year-over-year in May, matching the previous month's pace and remaining well above the Fed's 2% target. On a monthly basis, core PCE increased 0.3%, in line with April's gain. The persistent rise in core prices suggests underlying inflationary pressures are not easing quickly.
Services Prices Drive the Increase
The main driver of the May inflation uptick was a sharp increase in services costs, which rose 0.5% from April. Housing and utilities, healthcare, and transportation services all contributed to the rise. Goods prices, by contrast, edged up just 0.1% month-over-month, with a decline in energy goods partially offsetting increases in other categories. Food prices rose 0.2%.
Impact on Federal Reserve Policy
The stronger-than-expected inflation reading is likely to reinforce the Federal Reserve's cautious stance on interest rate cuts. Following the data release, market expectations for a rate cut at the Fed's July meeting fell to around 10%, down from 15% a day earlier. The Fed has held its benchmark interest rate at 5.25%-5.50% since July 2024, and Chair Jerome Powell has repeatedly emphasized the need for more evidence that inflation is sustainably moving toward the 2% target before easing policy.
Consumer Spending and Income Data
Personal spending rose 0.3% in May, slightly below the 0.4% forecast, while personal income increased 0.4%, matching expectations. The saving rate edged down to 3.5% from 3.6% in April, indicating that consumers are dipping into savings to support spending amid high prices. The data underscores the resilience of the US consumer, but also the strain from persistent inflation.
Reaction from Economists
"This is an unwelcome reminder that the last mile of inflation is proving sticky," said Sarah Johnson, chief economist at Capital Economics. "The Fed will need to see several months of softer readings before it can be confident that inflation is on a sustained downward path. We now expect the first rate cut to occur in December at the earliest." Other analysts echoed similar sentiments, noting that the services sector remains a key area of concern for policymakers.
Market Response
US stock markets opened lower on Friday following the inflation data, with the S&P 500 falling 0.5% in early trading. Treasury yields rose, with the 10-year note yield climbing to 4.45% from 4.40% the previous day. The US dollar strengthened against a basket of major currencies, reflecting expectations that the Fed will keep rates higher for longer.
Looking Ahead
The May PCE report is the last major inflation data point before the Fed's next policy meeting on July 29-30. While the central bank is widely expected to hold rates steady, the stubbornly high inflation reading could lead to more hawkish language in the post-meeting statement. Investors will also focus on the June consumer price index report, due out on July 11, for further clues on the inflation trajectory.
