The Federal Reserve's favorite inflation measure came in hotter than expected in July, and that's making the broader economic picture more complicated.
Inflation refused to cool down
The PCE price index rose 3.7% annually in July. That matched June's reading exactly, meaning inflation made zero progress for the month.
Economists had forecast a dip to 3.6%. Monthly PCE rose 0.2%, reversing June's 0.1% decline, which had been the weakest monthly reading since April 2020.
Core PCE, which strips out food and energy, held at 3.3% annually and rose 0.2% on the month. That was in line with forecasts, but still nearly 70% above the Fed's 2% target.
The unrounded core monthly figure was 0.246%, which nearly rounded up to 0.3%, according to Omair Sharif of Inflation Insights. That translates to a one-month annualized rate of nearly 3.0%.
Goods prices fell 0.1% on the month. Services prices rose 0.3%, driven by a 1.2% jump in financial services and insurance and a 0.3% gain in housing costs.
What's keeping inflation this high
The story has two main drivers. The first is war. The US and Israel launched air strikes against Iran in late February, sending energy prices sharply higher as the conflict shut in roughly a fifth of global oil supplies.
Annual PCE hit a three-year high of 4.1% in May before pulling back. Gas currently sits around $4 per gallon, with diesel near $5.60.
The second driver is tariffs. President Trump's wave of import tariffs pushed goods prices higher starting last year. Now fresh pressure is building after trade negotiations with Canada collapsed, triggering new levies on $20B of Canadian imports.
The AI boom is adding a third, less obvious layer. Surging demand for computer chips is pushing up prices in that category, and it's showing up in business investment data.
The economy isn't giving the Fed any cover
Normally, stubborn inflation alongside a slowing economy creates a difficult tradeoff. Right now, the economy isn't slowing.
Second-quarter GDP growth was confirmed at 1.5% annualized in the latest estimate, unchanged from the initial report. Consumer spending within that figure was revised up to 3.4% from 3.2%.
Real final sales to private domestic purchasers, a measure of combined consumer and business spending that excludes government and trade, grew at 4.2% in Q2. That was the strongest reading since Q1 2023.
Corporate profits jumped $400.9B in Q2, the second-largest increase on record. Business investment remained strong, driven by continued AI infrastructure spending.
Economists now expect Q3 GDP growth of at least 3%, which would be double the Q2 rate, according to Kathy Bostjancic of Nationwide.
Personal income rose 0.4% in July, outpacing inflation. The personal savings rate climbed to 3% from 2.6% in June. Both could support stronger consumer spending later this year.
What this means for rates in September
The Fed's benchmark rate sits at 3.50% to 3.75%, where it has been since December. Most policymakers voted last month to hold steady, but a growing minority want tighter policy.
"The Fed's challenge is clear: It still has considerable ground to cover before markets see 2% inflation as a credible outcome rather than a distant aspiration."
Olu Sonola, Fitch Ratings
After the July PCE report, fed funds futures markets priced in roughly a 40% probability of a rate hike at the Sept. 15-16 meeting, up from about 36% beforehand. The other 60% expects the Fed to hold.
Fed Chairman Kevin Warsh is scheduled to speak at the Jackson Hole symposium on Friday. He's been cautious about signaling next moves, but investors will be watching for any shift in tone after a report that delivered no progress on inflation and a growth picture that's getting hotter.