Core PCE inflation rises, signalling continued inflation pressures in the US

Following recent declines in the consumer price index (CPI), much attention focused on the release of the personal consumption expenditures (PCE) price indices for August. EFG Chief Economist Stefan Gerlach looks at what the data tell us in this Macro Flash Note.

The release of PCE inflation¹ for August will have disappointed the Fed. Headline PCE inflation fell to 6.2% year-on-year (y/y) in August (0.3% month-on-month) after falling to 6.4% in July (0.1% m/m). Year-on-year, goods prices rose 8.6%, services prices increased by 5.0%, food prices increased 12.4% and energy prices were up 24.7%. This is the second month in a row that headline PCE inflation has declined. However, core PCE inflation rose to 4.9% y/y (0.6% m/m) after falling to 4.6% in July (0.1% m/m). The Fed views core PCE inflation as particularly informative about underlying inflation pressures and will be concerned by this increase. In our view, these data boost the likelihood that the Fed will continue to raise interest rates in its coming meetings.

Source: BEA, data as of 30 September 2022.

Prior to 2000, the Federal Open Market Committee focused on CPI inflation but, following an extensive review, decided to change² to PCE inflation. PCE is normally below CPI inflation because of differences in how the indices are constructed. There are three main differences.³

The first concerns the weights applied to different goods. While the CPI is based on surveys of household purchases, the PCE is based on surveys of what businesses are selling.

The second concerns the coverage or scope of the indices. The CPI covers out-of-pocket expenditures on goods and services purchased but excludes other expenditures that are not paid for directly, for example, medical care. These are included in the PCE.

The third difference arises from how the indices account for changes in the basket. While the PCE accounts for substitution between goods when relative prices change, the CPI updates the basket regularly.

Despite falling in August, PCE inflation remains too high for the Federal Reserve to feel comfortable that inflation is returning towards 2%. Hence, there is a high probability that the Fed will again raise rates forcefully at its next meeting on 2 November.

¹ https://www.bea.gov/news/2022/personal-income-and-outlays-august-2022-and-annual-update

² http://www.federalreserve.gov/boarddocs/hh/2000/February/FullReport.pdf

³ https://www.clevelandfed.org/newsroom-and-events/publications/economic-trends/2014-economic-trends/et-20140417-pce-and-cpi-inflation-whats-the-difference.aspx

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