Fed’s key inflation gauge hits 3.5% as Iran war pushes up gas prices

(CNN) — Fast-rising gas prices lifted the Federal Reserve’s preferred inflation gauge to 3.5% in March, its highest rate in almost three years, new data showed Thursday.

The Personal Consumption Expenditures price index rose 0.7% from February, a faster-than-expected acceleration from the previous monthly pace of 0.4%, the Commerce Department reported Thursday.

The annual rate of inflation, which jumped from 2.8% in February, is now running at its fastest pace since May 2023.

The upswing in inflation was expected. Gas prices rose at record rates in March, aftershocks of the Middle East conflict’s squeeze on the oil trade. Unfortunately, there’s little relief on the horizon: Prices at the pump remained high through April, and an energy shock like this is slowly making its way through other goods and services in the economy.

But for Americans already weighed down by years of prices rising faster than they normally do and facing a labor market that’s downshifted in speed, it’s not a welcome development, said Elizabeth Renter, senior economist at NerdWallet.

“We’re seeing it in the consumer sentiment data – not only are people feeling the pressure of affordability, specifically in gas prices, but also they’re looking out around them and saying, ‘Hey, one of the solutions to high expenses is making more money, and I really don’t have the opportunity to do that in this job market,’” she told CNN in an interview.

“The economy is holding on,” she added. “I don’t think we’re careening toward disaster at the moment, but I do think it’s getting increasingly uncomfortable.”

Resiliency in the face of a shock

The US-Israeli war with Iran, which is now entering its ninth week, has sent shockwaves through the global economy. Shipping traffic in the Persian Gulf and the Strait of Hormuz has slowed to a trickle, choking off a vital waterway for the trade of oil, natural gas, fertilizer and other critical materials.

Economists were expecting the March PCE price index – like other inflation gauges before it – to reflect the record monthly rise in gasoline prices. Consensus estimates on FactSet showed an anticipated 0.6% monthly increase and for the annual rate to jump to 3.6%.

When excluding food and energy costs, prices rose 0.3% from the month before (a slight downshift from the 0.4% monthly gain notched in February) and increased 3.2% on an annual basis. That’s in line with what economists were expecting; however, the annual rate did move up from 3%.

“Inflation was high when we went into this mess with Iran; it was already running hot,” Renter said. “Even if you take out the effects of the war in Iran, price growth is climbing, which is cause for concern.”

With the overall PCE price index now rising at a 3.5% annual rate, inflation is running above the Federal Reserve’s 2% target. On Wednesday, policymakers for the US central bank opted to keep interest rates steady as the war puts upward pressure on inflation.

Fed Chair Jerome Powell said Wednesday that the current policy stance is in “a very good place for us to wait and see,” and that despite inflation “misbehaving,” the economy has remained resilient.

Separate federal data released Thursday added some support to that resiliency diagnosis: The economy grew at a 2% annualized rate during the first quarter; the estimated 189,000 jobless claims filed last week mark a nearly 60-year low; and workers’ wages and benefits rose at a stronger-than-expected rate of 3.4% during the first quarter.

‘Buckle in and be patient’

Americans have had to adjust to sharply rising gas prices; however, the energy shock hit at a time when many consumers’ coffers were buffered a bit by larger tax refunds. Additionally, wage gains, although slowing, continue to outpace inflation, and some Americans are seeing wealth boosts from rising stock and home values.

The US economy does appear to still have “some gas in the tank,” but how much longer households can sustain high oil prices and potential accelerations in inflation remains a key question, noted Scott Anderson, chief US economist at BMO Capital Markets.

“If inflation pressures continue to build in the months ahead, it will be more and more difficult for consumers to keep up,” Anderson wrote in a note to investors on Thursday. “The rapid drop in the personal saving rate since the beginning of the year is a cautionary flag as we move into the second quarter.”

In addition to the PCE price index, which the Federal Reserve uses for its 2% inflation target, Thursday’s Commerce Department report also provided a look at how households’ spending, income and savings were holding up.

Consumer spending jumped 0.9% from February, but when taking inflation into account, it rose just 0.2%.

The dollars consumers put in their gas tanks and toward other energy goods accounted for 42% of the month’s spending change, Commerce Department data shows.

Households’ personal and disposable (after-tax) income both rose at 0.6% paces in March; however, when accounting for inflation, disposable income dropped by 0.1%, the second consecutive monthly decline.

The personal saving rate fell for the second month in a row as well, dropping to 3.6% from 3.9% and landing at the lowest rate in four years.

Looking forward, Americans are going to have to “buckle in and be patient” when it comes to gas prices, as well as overall inflation, NerdWallet’s Renter said.

US average gasoline prices hit a four-year high of $4.30 per gallon on Thursday, according to AAA.

“If the conflict ends sometime soon, and oil is flowing again in the Middle East, it’s going to still take a while for gas prices to come down,” she said. “I think consumers should prepare for the high gas prices to extend through the summer months, if not into the fall, depending on the length of the conflict.”

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