Why The Fed May Need You To Stop Spending So Much Money

Consumer spending has buoyed the economy since the pandemic, but it could also be a stumbling block for the Federal Reserve’s progress on taming inflation.

The Federal Reserve’s preferred measure of inflation rose 2.5% from the year before, down from 2.6% in May, according to a Friday report on Personal Consumption Expenditures (PCE) from the Bureau of Economic Analysis. The slight downtick is progress on taming inflation, however slight. Inflation is at the same level as in February and still half a point higher than the Fed’s annual goal.

Federal Reserve Chair Jerome Powell has said the central bank won’t wait until inflation hits its target to cut interest rates that have made borrowing for consumers and businesses the most expensive in decades. However, Fed officials say they do have to be confident inflation is on the way there.

Despite calls to lower rates in their meeting next week, the Fed is widely expected wait to start easing until the following meeting in September.

Continued Spending Could Fuel Stubborn Inflation

The inflation Friday report also gave insight into consumer spending, earnings, and savings, all a part of the Federal Reserve’s equation.

“For those looking for another reason on why the Fed may not be so apt to ease policy at next week’s meeting, look no further than services sector spending,” wrote Wells Fargo Economists Tim Quinlan and Shannon Seery Grein.

The report showed consumers spent 0.3% more in June than in the month prior with an emphasis on services, which is indicative of the larger consumer spending landscape. Consumer spending is a vital part of the country’s economic growth, but it can also fuel inflation because high demand could push up prices.

“Consumers aren’t spending the way they used to, but are still providing ongoing support to the expansion,” wrote BMO’s Senior Economist Sal Guatieri.

Savings Will Eventually Run Out

Consumer spending has slightly downshifted this year, as economists suspect consumers are finally succumbing to inflation pressures and high borrowing costs. In turn, consumers are saving less so they can keep spending.

The saving rate fell to 3.4% in June, which Nationwide Chief Economist Kathy Bostjancic pointed out was less than half the pre-pandemic rate of 7.7% rate.

Because of the dwindling savings, unbridled spending can’t last though, economists said.

“Real spending growth has gained some momentum, but this will not prove sustainable,” wrote Scott Hoyt, an economist at Moody’s Analytics. “Year-over-year growth should be near its peak and begin to slow, although the slowing will be gradual.”