Small Increase in Spending; Inflation Remains Way Too High for Fed

• Real after-tax income fell 0.3% in June, with nominal income up 0.6%. 

• Real consumer spending rose a modest 0.1% in June, with nominal spending up 1.1%. 

• Inflation was very high in June, with soaring energy prices. The PCE price index was up 6.8% in June from one year earlier, with core PCE inflation at 4.8%. Both of these are far above the Fed’s 2% target. 

• Real consumer incomes and spending should increase modestly through the rest of this year. 

• Inflation will slow in July with falling energy prices. 

• Federal Reserve interest rate increases are weighing on economic growth, and recession risks are elevated.

After-tax income fell 0.3% in June from May, after adjusting for inflation, according to the Personal Income and Outlays report from the Bureau of Economic Analysis. Even though the labor market is very strong, real income growth is weak in mid-2022 because of high inflation. Nominal personal income rose 0.6% for the month and has been increasing at around this pace since February. Nominal wages and salaries rose 0.5% in June with more jobs and higher wages. 

Real consumer spending rose a small 0.1% in June. Real spending fell 0.3% in May but has increased modestly in three of the past four months. Nominal spending rose 1.1% over the month, in part because of higher gasoline prices. 

With nominal spending up more than incomes, the personal saving rate fell to 5.1% in June, from 5.5% in May, and from around 8% in late 2021. Households are responding to higher inflation by spending down some of the savings they accumulated in 2020 and 2021 from government assistance and reduced opportunities to spend earlier in the pandemic. 

The personal consumption expenditures price index jumped 1.0% in June from May, the largest one-month increase since 2005. Energy prices soared 7.5% over the month. The core PCE price index, excluding volatile food and energy prices, rose a strong 0.6% in June, after increases of 0.3% in each of the three previous months. 

On a year-ago basis headline, PCE inflation was 6.8% in June, up from 6.3% in May. This was the highest PCE inflation since 1981. Core PCE inflation was 4.8% year-over-year in June, up from 4.7% in May, but down from above 5% in the first quarter. Both of these measures are running far above the Federal Reserve’s 2% inflation objective. 

The June Personal Income and Outlays report was a mixed bag. Consumer spending rose modestly over the month, after adjusting for high inflation, but growth has slowed from 2021. Real incomes fell, even with job gains and strong nominal wage growth, due to high inflation. Higher prices, particularly for energy and food, have caused consumers to turn more cautious. But real spending is still growing, as households draw down on the saving they accumulated in 2020 and 2021. Households still have some $2 trillion in extra savings compared to before the pandemic, and also good access to credit, which are somewhat offsetting the impact of high inflation. A huge drop in gasoline prices in July will provide some temporary support to consumer spending. Other positives for near-term consumer spending are the very strong labor market and rising home values. But higher interest rates and the big drop in stock prices in the first half of the year will be drags. PNC expects modest growth in inflation-adjusted consumer spending through the rest of this year and into 2023 

As long as households continue to buy, the economy should avoid recession. Consumer spending will continue to shift from goods to services. Consumers bought a lot of goods early on the pandemic, with limited opportunities for spending, but are now picking up their spending on services as they continue to venture out. 

Inflation-adjusted income should also grow modestly in the near term. Job gains and wage growth will support increases in nominal income, and real incomes will increase with lower inflation. But slower job growth will weigh on income gains in 2023. 

Inflation remains far above the Federal Reserve’s 2% objective. In response, the Federal Open Market Committee has been aggressively raising the federal funds rate, its key short-term interest rate, since the spring. PNC expects further increases in the fed funds rate through the rest of 2022 and into early 2023. Higher rates are already weighing on economic activity. This is most notable in the housing market, where sales and starts have slowed dramatically in recent months as the typical 30-year fixed mortgage rate has increased from below 3% in 2021 to around 5.5% currently. 

The central bank’s hope is that higher interest rates and slower economic growth can curb inflation but without a recession. However, recession risks are elevated: PNC puts the probability of recession over the next two years at around 45%, more than double what it was prior to the Russian invasion of Ukraine.

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.