But Big Increase in January Consumer Spending; Inflation Up Even More
- Personal income was flat in January from December, as a drop in government transfer payments offset an increase in labor market income.
- Consumer spending jumped more than 2% over the month as households continued to buy, despite omicron.
- The saving rate fell to its lowest since 2014, although the decline is temporary.
- Inflation remained high, with year-over-year inflation at the fastest pace in decades.
- The outlook for consumer incomes and spending remains positive for the rest of 2022.
- Inflation should slow in 2022 as the Federal Reserve raises interest rates, although the Russian-Ukraine conflict adds upside potential to inflation.
Personal income was flat in January from December, before accounting for inflation, and after-tax personal income was up 0.1% over the month. Wages and salaries increased a solid 0.5%, but government transfer payments declined more than 1% as an end to monthly child tax credit payments offset the annual increase in the Social Security inflation adjustment. The flat income in January followed three straight months of solid income growth.
But while income growth was weak, consumer spending increased an excellent 2.1% over the month, the biggest gain since March of last year. Goods spending was up 5.2% over the month, while services spending increased 0.5%, despite concerns about the omicron variant.
With spending up much more than income the personal saving rate fell to 6.4% in January from 8.2% in December; this is the lowest monthly saving rate since 2013. But low savings is not a near-term concern; households, in aggregate, still have about $2 trillion saved up from earlier in the pandemic, and some of the January drop in saving came from a reduction in child tax credit payments. Households will adjust to the reduced tax credit and the saving rate will return to above 7% over the rest of 2022.
The personal consumption expenditures price index rose 0.6% in January from December, near the pace of the past few months, but well above the 0.1%-0.2% average before the pandemic. Durable goods inflation was especially strong at 1.0%, but services inflation was a hefty 0.4%, although this was down from 0.5% increases in the previous two months. The core PCE price index, excluding volatile food and energy prices, was up 0.5%; it has been running at this pace since October. Food prices rose 0.9% in January, with energy prices up 1.1%.
On a year-ago basis overall PCE inflation was 6.1% in January, up from 5.8% in December. The core PCE price index was up 5.2% in January from a year earlier, an acceleration from 4.9% in December. Both of these year-over-year inflation rates were the highest since the early 1980s, and well above the Federal Reserve’s 2% inflation objective.
After adjusting for high inflation in January after-tax personal income was down 0.5% over the month. But real consumer spending growth was still very good, at 1.5%, more than making up for the 1.3% decline in December.
This morning’s report on personal income and outlays was a mixed bag. Household income was flat with an end to monthly child tax credit payments, but personal income was up strongly. Real household income fell after taking into account higher prices, but real consumer spending was up sharply after a drop in December.
The outlook for household incomes and spending remains positive for 2022. Job growth is strong and wages are rising quickly thanks to the tight labor market; this will more than offset the drag from an end to the expanded child tax credit. Households also have an extra $2 trillion in saving compared to before the pandemic; this will allow them to continue to increase their spending, even as government support wanes. High household wealth is also a support; although the recent decline in stock prices could limit the positive impact, stock prices are still well above their pre-pandemic levels, and home values are at record highs and still rising quickly.
Consumer spending growth will shift from goods to services over the course of 2022; goods spending is well above its pre-pandemic level, even after adjusting for prices, while services spending is still 1% below where it stood in early 2020, before the pandemic. Thus, as the pandemic fades and consumers feel more comfortable going out, services spending growth will accelerate, while goods spending growth will cool off.
Inflation is a big concern, however. With PCE inflation running at its fastest pace in four decades, rapidly rising prices are eating away at real incomes and savings. In addition, the Federal Reserve will aggressively raise interest rates this year in an effort to cool down growth and inflationary pressures, making it more expensive for households to borrow. The Russia-Ukraine conflict could add to inflationary pressures because of higher energy prices, perhaps forcing the Fed to act even more aggressively. PNC’s February forecast calls for the Federal Open Market Committee to raise the federal funds rate 5 times in 2022, by 25 basis points each time, which would bring the rate to a range of 1.25% to 1.50% by the end of this year.
But inflation should slow on a year-ago basis over the course of 2022. Comparisons with early 2021, when prices were increasing very rapidly coming out of the pandemic, will drop out of the data. And goods inflation should cool this year as businesses rebuild their supply chains. Still, inflation will broaden to more categories as higher wages and housing costs seep into services prices. PCE inflation will end this year at around 3% on a year-over-year basis, still higher than the Fed would like. But slower growth in 2023 will push inflation back down to the central bank’s 2% objective. Near-term inflation risks are to the upside, however, due to the Russia-Ukraine conflict.
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