Consumers Still Holding Up OK

• Inflation slowed in July, with a small decline in the overall PCE price index and a small increase in the core index over the month. Both measures slowed year-over-year in July from June but remain far above the Fed’s 2% inflation objective. Energy prices fell sharply in July.
• There was a modest increase in household income in July, although there was very good growth in wages and salaries.
• Consumer spending rose modest in July.
• Consumer spending growth is slowing but should remain positive in the near term. Recession risks are elevated, however.

The personal consumption expenditures price index fell 0.1% in July from June, the first drop in overall prices since April 2020, when the pandemic first hit the US economy. After months of very high inflation, the small drop in prices was welcome. The core PCE price index, excluding food and energy, rose a modest 0.1% in July, the smallest increase since February 2021. Energy prices fell almost 5% in July, but food prices were up 1.3%, the sixth straight month of increases of 1% or more.

The PCE price indices are the Federal Reserve’s preferred inflation measures. On a year-over-year basis, overall PCE inflation was 6.3% in July, down from 6.8% in June. Core PCE was 4.6% year-over-year in July, down from 4.8% in June. Although inflation slowed in July, both overall and core remain far above the Fed’s 2% objective and is running at close to the fastest pace in 40 years.

Personal income increased 0.2% before inflation in July from a month earlier. Wages and salaries were up a strong 0.8% over the month, but there were sizable declines in self-employment income, rental income, and government transfer payments. After-tax personal income was also up 0.2% in July. After adjusting for falling prices, real after-tax income was up 0.3% for the month.

Consumer spending rose 0.1% in July from June. There was a big drop in nominal spending on nondurable goods as energy prices plunged in July. After adjusting for inflation, real consumer spending rose 0.2% over the month. Consumer spending in June was flat from May, revised lower from a 0.1% increase, although May real spending was revised somewhat higher to a 0.1% decline, from a 0.3% decline.

With small increases in both spending and after-tax income, the personal saving rate held steady at 5.0% in July from June (revised lower from 5.0%); this is the lowest saving rate since 2009. With high inflation, consumers have been spending down the saving they accumulated in 2020 and 2021.

The personal consumption and expenditures report was solid. There were modest increases in personal income and consumer spending, but growth in wages and salaries was strong, which bodes well for near-term spending growth. The declines in self-employment earnings, rental income, and government transfers are likely to reverse in the months ahead. There was soft growth in consumer spending, especially after adjusting for a small drop in prices.

Households continue to adjust to high inflation over the past couple of years, the loss of government income support, and now higher interest rates. But with inflation slowing; the labor market very strong, with a solid job and nominal wage gains; excellent consumer credit quality; and households in aggregate still with a lot of leftover savings from earlier in the pandemic, moderate consumer spending growth should continue over the next couple of years, although it will slow from its pace in 2021. With consumer spending making up about two-thirds of the economy, the US should be able to avoid a near-term recession, although risks are elevated.

Inflation appears to have peaked in mid-2022 and should slow on a year-over-year basis through the rest of this year and in 2023. Falling commodity prices, a stabilization in food prices, and an easing in supply chain pressures will push down near-term inflation, although consumer services prices continue to increase steadily with the tight labor market and a big increase in rents over the past couple of years. But for inflation to continue slowing in 2023 the labor market must loosen a bit. The Federal Reserve is raising interest rates to cool off growth, and the impact is already showing up in a slowing housing market. The open question is whether the Fed can calibrate its rate increases finely enough to push inflation down to 2% over the next couple of years, but without pushing the economy into recession.

PNC expects a 50 basis point increase in the fed funds rate at the Federal Open Market Committee’s next meeting, on September 21. The slowing in inflation in today’s PCE report supports a smaller increase in the fed funds rate in September, after increases of 75 basis points in both May and June. But between now and the FOMC meeting is the August jobs report (September 2) and the August CPI report (September 13), and those could change the outlook.

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.