Small Increases in Nominal Income and Consumer Spending

• PCE inflation accelerated in February to its highest year-over-year levels in four decades.
• Both household income and consumer spending rose slightly in February from January but declined after accounting for high inflation.
• Even with high inflation, the fundamentals for consumer spending are positive, and household purchases will continue to increase throughout 2022.
• The Federal Reserve will raise short-term interest rates throughout 2022 to slow growth and cool off inflation.

Inflation in February accelerated to the fastest year-over-year pace in decades using the personal consumption expenditures price index from the Bureau of Economic Analysis. Overall consumer prices were up 6.4% in February from one year earlier, compared to 6.0% inflation in January. For core inflation, excluding food and energy, year-over-year inflation was 5.4% in February, up from 5.2% in January. This was the fastest overall inflation since early 1981, and the fastest core inflation since early 1983.

On a month-to-month basis the overall PCE price index increased 0.6% in February, an acceleration from 0.5% increases in each of the preceding two months. There was a slight slowing in month-to-month core inflation in February to 0.4%, after 0.5% increases in October 2021 through January 2022.

Personal income rose 0.5% in February from January, before accounting for inflation. Employee compensation was up 0.7% for the month, including a 0.8% increase in wages and salaries. Transfer income fell for a second straight month after the expiration of the expanded child tax credit at the beginning of the year. After-tax income rose 0.4% in February.

Consumer spending increased 0.2% in February from a month earlier, after a big 2.7% increase in January. Spending in durable goods fell 2.5% in February, with spending on nondurable goods down 0.1%. Spending on services rose 0.9% over the month.

With after-tax income up more than saving in February, the personal saving rate rose slightly to 6.3%, up from 6.1% in January.

After adjusting for inflation after-tax income fell 0.2% in February from January, while inflation-adjusted spending fell 0.4% over the month. Even with the decline over the month consumer spending is running well above its fourth-quarter pace, as real consumer spending surged 2.1% in January. Household consumption will be a solid contributor to economic growth in the first quarter.

Inflation took a bite out of household incomes and spending in February and will be an even bigger drag in March with surging energy prices in the wake of the Russian invasion of Ukraine. In spite of that, however, inflation-adjusted consumer spending in the first quarter of 2022 will be higher than in the fourth quarter of 2021, and the economic expansion is continuing.

Although high inflation is a negative for household spending, the overall outlook for consumers is positive. On average households have a lot of money saved up from the early stages of the pandemic, when spending declined and the government provided additional assistance. Other positives for consumer spending growth through the rest of this year are strong job and wage growth and high household wealth, thanks to soaring home values and a strong stock market, even with the recent decline in equity prices. Pent-up demand for some goods currently in short supply, especially autos, will also support household spending growth later this year and in early 2023 as supply chains normalize and availability increases. Overall, however, consumer spending growth shift from goods to services in 2022 and 2023 as the pandemic hopefully continues to fade, consumer feel more comfortable going out, and governments continue to remove restrictions.

The PCE price index is the Federal Reserve’s preferred inflation measure, and both overall and core inflation are running far above the Fed’s 2% objective, and in fact moved even higher in February. Inflation will accelerate again in March with higher energy prices following the conflict in Ukraine. But the inflation story is more than just energy; other factors contributing to higher inflation are supply-chain disruptions and higher labor and non-labor input costs.

The Federal Reserve is raising short-term interest rates in an effort to cool off economic growth and slow inflation. The Federal Open Market Committee raised the federal funds rate by one-quarter of a percentage point at its mid-March meeting to a range between 0.25% and 0.50%. PNC expects the FOMC to raise the fed funds rate by an additional cumulative 1.75 percentage points through the rest of this year, to a range of 2.00% to 2.25% by the end of 2022, with additional rate hikes likely in 2023. The Fed will also start to reduce its balance sheet in the next couple of months, which is putting upward pressure on long-term interest rates.

With a fading in supply-chain disruptions, a gradual decline in energy prices, and a slowing in economic growth, PNC expects overall PCE inflation to slow to around 4% by the end of 2022, and then to close to the Fed’s 2% objective by the end of 2023. 

The PNC Financial Services Group, Inc. is one of the largest diversified financial services institutions in the United States, organized around its customers and communities for strong relationships and local delivery of retail and business banking including a full range of lending products; specialized services for corporations and government entities, including corporate banking, real estate finance and asset-based lending; wealth management and asset management. For information about PNC, visit www.pnc.com.