The Fed’s Preferred Measure Of Inflation Heated Up In March

A government report confirmed what people have already seen on their trips to the gas station and grocery store: inflation is staying too high for comfort.

The cost of living, as measured by the Personal Consumption Expenditures (PCE) index, rose 2.7% over the last year in March, up from a 2.5% annual increase in February, the Bureau of Economic Analysis said Friday. The uptick, driven largely by increases in food and energy prices, was slightly higher than the expectations of forecasters, according to a survey of economists by Dow Jones Newswires and the Wall Street Journal. 

Other Measures Foretold the Increase

The Consumer Price Index already showed overheated inflation earlier this month when the Bureau of Labor Statistics released it. But PCE inflation is more significant for the direction of interest rates because it’s closely watched by officials at the Federal Reserve who set the nation’s monetary policy.

“It’s going the wrong way,” said Dan North, senior economist at Allianz Trade.

The two major inflation measures are both based on surveys of prices of the things people buy but are calculated differently, with PCE inflation putting less emphasis on housing, for example. Hot inflation as shown by the PCE is bad news for anyone waiting for lower interest rates on things like mortgages and credit cards. 

After Thursday’s report on Gross Domestic Product (GDP) showed higher than expected inflation for the entire quarter, some economic watchers worried it belied a drastic increase in inflation. January’s annual rate was revised, up from 2.4% to 2.5%. That could come as a relief to some market watchers who were worried the quarterly figure would drastically change the outcome for March.

Inflation’s Core Is Heating Up

The Fed has been holding the influential fed funds rate at its highest since 2001 to combat inflation, putting upward pressure on interest rates on all kinds of loans. Fed officials have said they’re waiting for data showing inflation is firmly on the path to a 2% annual rate before they’ll cut the fed funds rate. 

The details of Friday’s report held another bad sign for interest rates: “core” inflation, which excludes volatile prices for gas and energy, rose 2.8% over the year, the same as in March, and higher than the drop to 2.7% that the median forecast had anticipated. Economists watch core inflation because it is a better indicator of long-term inflation pressures since it leaves out prices that tend to swing up and down for temporary reasons like the weather.

The report also showed consumers have plenty of firepower to keep spending, and are using it. Personal income rose 0.5% in March from February, up from a 0.3% monthly increase in February, supported by salaries in a labor market that still favors workers. Spending rose even faster at a 0.8% clip, the same as in February.

That’s along the same lines as Thursday’s report on the Gross Domestic Product, which showed consumer spending was still powering the economy ahead, despite some factors, including rising imports, making economic growth seem slower on paper.

“You’ve got to go under the hood,” North said of the GDP report. “The hood is rusty, but underneath, it’s really not so bad.”

That too has implications for rate cuts, since consumer spending is the main engine of the country’s economy, and if it’s going strong, the Fed has less reason to cut interest rates to stimulate growth.

Fed Can’t Get Confident with Numbers Like These

The streak of bad inflation reports this year combined with evidence that growth is still surging ahead is likely to discourage the Federal Reserve Chair Jerome Powell and other officials from cutting interest rates through at least November, North said.

“If you’re Jay Powell, and you’re looking at the growth side of the economy, you’re saying, ‘Well, it’s doing fine—look at personal consumption, look at the labor market. It doesn’t need any stimulus, so I don’t need to cut rates from that perspective,'” he said. “And if I look at the inflation side: To look at that core number, we’re at 2.8%. That’s not 2%. …We’re a long, long way from that as well. So this just keeps Jay Powell out for several months.”