PCE, the Fed’s preferred inflation gauge, shows that prices are cooling

Minneapolis
CNN
—

The trend is clear: Inflation is cooling in America.

The Federal Reserve’s preferred measure of inflation showed that price increases continued to slow in November, providing another welcome indication that the period of painfully high prices has peaked.

The price index for personal consumption expenditures, or PCE, rose 5.5% in November from a year earlier, the Commerce Department reported Friday. It is lower than in October, when prices rose 6.1% annually.

In November alone, prices rose just 0.1% from October.

Core PCE, which excludes the volatile food and energy categories, was up 4.7% annually and 0.2% monthly, in line with the expectations of economists polled by Refinitiv.

The annual increases for both PCE inflation indices reached their lowest levels since October 2021 and follow continued declines in other inflation gauges, such as the consumer price index and the producer price index.

PCE, specifically the core measure, is the Fed’s preferred inflation gauge, as it provides a more complete picture of costs to consumers.

Friday’s report also showed that spending continued to rise in November, but at a much slower pace than in previous months. Spending increased by 0.1% in November compared to 0.8% the previous month. Personal income increased by 0.4% in November, down from 0.7% in October.

The November PCE report, the last major inflation gauge to be released in 2022, provided a snapshot of an economy in transition. Tasked with curbing the highest inflation since the early 1980s, the Fed has implemented a series of large interest rate hikes to curb demand.

In its seven meetings starting in March, the central bank’s policy arm raised its benchmark interest rate by a cumulative 4.25 percentage points. The sharp rise in interest rates has begun to filter through the economy, with the effects showing first in areas such as real estate, where mortgage rates were 6.27% this week, more than double what they were at this time last year, according to Freddie Mac data.

“The economy is moving in the right direction from the Federal Reserve’s perspective at the end of 2022, but not fast enough,” Gus Faucher, chief economist for PNC Financial Services, said in a statement. “Higher interest rates are weighing on consumer spending, especially on durable goods, and inflation is slowing.”

Inflation has moderated in recent months, particularly in durable goods as supply chain bottlenecks eased and consumers focused more on areas such as leisure and hospitality.

However, inflation in the service sector has been a bit “sticky” and has not slowed down as quickly. Friday’s PCE report showed the services index posted a monthly increase of 0.4% — unchanged from October’s rate — and a year-over-year increase of more than 11%, Faucher noted.

While much of the service inflation is due to housing costs, which are reversing quickly, the Fed is concerned that strong wage growth could lead to sustained increases in service prices and overall inflation, he added.

“The Federal Open Market Committee will continue to raise interest rates in early 2023 until it becomes clearer that the labor market is cooling, and wage growth and services inflation are slowing to more sustainable paces,” he added.

The Fed’s latest economic projections released last week showed that board members expected inflation to remain slightly higher for longer than previous forecasts. Fed board members now expect PCE inflation to end 2023 at 3.1% and core PCE for next year at 3.5%, above the central bank’s target rate of 2%.

A separate Commerce Department report released Friday showed new orders for manufactured goods fell 2.1% in November, the biggest monthly drop since the outbreak of the pandemic.

Transportation equipment, particularly new orders for non-defense aircraft and parts, drove the decline, according to the report. Excluding transport, new orders increase by 0.2%.

Shipments increased 0.2% in November, which followed a 0.4% increase in October.

“Core durable goods orders eased but did not retreat, reflecting growing unease about the economy,” Diane Swonk, chief economist for KPMG, tweeted Friday after the report’s release. “Manufacturing activity has started to contract, and preliminary readings for December suggest it will contract further by the end of the year. A cold winter was in store for the industry.

Inflation’s slow march downwards has been welcome news for consumers as well, helping to cheer their economic sentiments during December, according to new data released Friday by the University of Michigan.

The final December reading for the index of consumer sentiment came in at 59.7 in December, up slightly from a preliminary reading of 59.1 and November’s final reading of 56.8, according to university consumer survey data.

“Consumers clearly welcomed the recent easing in inflation,” Joanne Hsu, director of Surveys of Consumers, said in a statement. “While sentiment appears to have turned a corner from the June low, consumers have reserved judgment on whether the trends will continue.”

She added: “Their outlook for the economy may have improved, but it remains relatively weak. The sustainability of robust consumer spending is dependent on continued strength in incomes and labor markets in the quarters ahead.”

The report showed the biggest improvement in sentiment about business conditions, while inflation expectations also improved, falling to 4.4% in December, the lowest reading in 18 months, according to the university. This is a key data point for the Federal Reserve. If consumers believe prices will remain high, this may lead to increased wage demands, which may cause businesses to raise prices.

Earlier this week, the Conference Board’s consumer confidence index — another measure of how consumers feel about the economy — hit its highest reading since April 2022.