July PCE Inflation Report: Core Inflation and Fed Policy Insights

Critical Insights from July PCE Inflation Report

The Fed's preferred inflation gauge for July should show a sustainable trend of disinflation, bolstering Federal Reserve officials' confidence as they eye interest rate cuts next month.

The Bureau of Economic Analysis is set to release the personal consumption expenditures price index at 8:30 a.m. Eastern on Friday. Economists surveyed by FactSet expect to see a slight annual increase in the pace of inflation to 2.6% from the 2.5% rate recorded in June.

That's largely driven by last year's so-called low base effects. When comparing the current level of inflation with last year's significant cooling, the percentage increase from that lower base level makes the year-over-year change appear slightly stronger.

Month-Over-Month Analysis

The more critical detail within the July PCE inflation data lies in the month-over-month figure, which is expected to register a 0.2% increase. That could bring the three-month annualized pace down to 2.0%, writes Kenneth Tjonasam, portfolio strategist at Global X. If this plays out, it might just be the signal the Fed has been waiting for, he said.

PCE inflation is still running above the Fed's 2% target, but officials have repeatedly noted—most recently Atlanta Fed President Raphael Bostic on Wednesday—that the central bank can’t wait until inflation is right at 2% to move away from its restrictive policy stance.

Core PCE Index Forecasts

The core PCE index, which excludes food and energy components and is considered a better gauge of where inflation is heading, is also forecast to tick up slightly to 2.7% year over year from June's rate of 2.6%. Yet economists expect Friday's data to show that the monthly pace of core inflation in July remained steady at 0.2% for the second consecutive month.

There are some risks worth watching for in Friday's data. Citi's Veronica Clark notes that wholesale used car prices rose again in August, reaffirming the risk of stronger used car prices in coming inflation reports. Additionally, median home prices rose again in July, an area worth watching as a possible source of inflation—particularly in a lower-rate environment where borrowing costs are less expensive, Clark said.

But the recent inflation trend has largely been positive news for both Fed officials and everyday Americans. On Thursday, the BEA revised down PCE inflation growth for the second quarter, which ended in June, by 0.1 percentage point to 2.5%. Core PCE was similarly revised down to a 2.8% annual pace in the second quarter.

So long as Friday's data continue on their positive trend, the Fed can focus on achieving a soft landing scenario, whereby the central bank manages to cool inflation without thrusting the U.S. economy into recession. Labor conditions—rather than inflation—will likely be a bigger driver of rate policy in the coming months. The key for the rest of this year will be the job market, writes Jeff Roach, chief economist at LPL Financial.