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The Fed’s favorite inflation gauge just heated up — and that could mean another rate hike

<i>Joe Raedle/Getty Images</i><br/>A customer looks over merchandise at a store on March 14
Joe Raedle/Getty Images
A customer looks over merchandise at a store on March 14

By Alicia Wallace, CNN

Minneapolis (CNN) — The US economy has encountered some expected turbulence on inflation’s descent.

The Federal Reserve’s preferred inflation gauge bounced higher in April, underscoring Fed Chair Jerome Powell’s warnings that reining in price hikes “is likely to be bumpy.” But with spending also heating up, Friday’s data from the Commerce Department kicked up the odds for further rate hikes.

The Personal Consumption Expenditures price index rose 4.4% for the 12 months ended in April, up from a 4.2% increase seen in March, according to data released Friday by the Commerce Department. Rising energy prices (up 0.7% month on month) helped push up the headline PCE index; prices for goods and services increased 0.3% and 0.4%, respectively, while food prices showed a very slight decrease.

The closely watched core PCE index — where volatile components of food and energy are excluded — unexpectedly ticked up: The Fed’s go-to gauge was up 4.7% for the year. In March, the core PCE gauge grew by 4.6%.

Economists had forecast that core PCE would hold steady at 4.6%, according to Refinitiv.

On a monthly basis, the headline and core indexes were both up 0.4%. In March, the headline PCE index showed a 0.1% gain, while core accelerated by 0.3%.

Economists polled by Refinitiv were expecting April’s monthly core price to increase 0.3%.

The PCE indexes are part of the Personal Income and Outlays report, which provides a more comprehensive look at shifts in prices, including how consumers respond to them and how much consumers are spending, bringing in and saving.

Consumer spending jumped 0.8% in April from March, double what economists had expected. Excluding the effects of inflation, real consumer spending increased 0.5%, reflecting a boost seen from new car purchases, according to the report. Household income ticked up to 0.4% from March; the prior month, personal income grew 0.3%.

As spending increased faster than incomes, the personal saving rate fell to 4.1% in April.

“Inflation has peaked and is moderating, but it remains much too high,” said Mark Zandi, Moody’s Analytics chief economist, in an email to CNN. “It is encouraging that the cost of housing services is moderating, reflecting weaker rents; but health care inflation is picking up, reflecting a tight health care labor market and quickly rising labor costs.”

He added: “It is critical that inflation moderate further, otherwise the Fed will continue to increase rates, which will ultimately undermine the economy and push it into recession.”

Another hike becoming more likely

Since March last year, the Fed has hiked its benchmark interest rate 10 consecutive times as part of efforts to cool demand and bring down high inflation.

At the central bank’s policymaking meeting earlier this month, Fed officials voted unanimously on a quarter-point rate increase. They also signaled that a pause could be on the table in June as they continued to evaluate the effects from the barrage of rate hikes as well as banks tightening their lending standards amid broader sector turmoil.

Just before the Commerce Department data was released on Friday, markets had the probability of a Fed pause at 54.2%, according to CME FedWatch. A little more than an hour later, those odds shifted to a 58.5% probability of a quarter-point hike next month.

“We’ve said we went back to normal [after the pandemic], but the problem is, that doesn’t mean inflation immediately goes back to normal,” Laura Veldkamp, finance professor at Columbia University’s Graduate School of Business, told CNN in an interview. “Inflation has taken on a life of its own.”

The deeply embedded and persistent inflation has been expected to come down slowly. However, if there are hiccups along the way and inflation accelerates, then it may mean that more aggressive policy is warranted, Veldkamp said.

The Fed hopes to meet its mandate without triggering a recession, but it’s a “delicate” process, she said.

“We’re walking a very fine line now, with a fairly rapid rate of interest rate increases,” she said. “It doesn’t seem to have caused a recession yet, but I think we’re dancing on the edge. And if we start to see prices go up more, which suggests they’re going to have to do more, I think it’s going to be very difficult to maintain that delicate balancing act.”

There are some indications that the economy is weakening: Growth is slowing and consumer spending is softer than it was last year amid persistently high inflation, increasing interest rates and rising recession concerns.

“The average consumer is in a worse place than they were a year ago, in terms of spending,” Sofia Baig, economist at decision intelligence company Morning Consult, told CNN.

The University of Michigan’s latest read on consumer sentiment showed that Americans’ economic outlooks weakened in May — driven down in part by the unresolved debt ceiling negotiations and fears of default. Consumers’ long-run inflation expectations ticked up to 3.1%, the highest level since June 2022, when inflation peaked.

“Consumer resilience has been supported by strong incomes thus far. However, high inflation continues to erode consumers’ living standards, and their confidence in the economy remains woefully negative,” said Joanne Hsu, director of the Surveys of Consumers.

“If the debt ceiling is breached, we will not be able to depend on consumer resilience to prop up the economy and avoid the catastrophic economic consequences to follow,” she said.

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