Fed Signals Rate Cuts as Inflation Cools: Economic Outlook Brightens

The inflation rate closely monitored by the Federal Reserve showed minimal growth last month, continuing a pattern of moderating price increases. This trend is paving the way for the Fed to lower its key interest rate for the first time in over four years next month.

Modest Price Increases

According to the Commerce Department’s report released on Friday, prices rose by just 0.2% from June to July, a slight uptick from the previous month’s 0.1% increase. Annually, inflation held steady at 2.5%, only slightly above the Fed’s target of 2%.

This slowdown in inflation challenges former President Donald Trump’s attempts to blame Vice President Kamala Harris for rising prices. However, despite easing inflation, many Americans remain dissatisfied with the higher average prices of essential goods like gas, food, and housing, which have increased significantly compared to pre-pandemic levels.

Core Inflation and Economic Trends

When excluding volatile food and energy prices, core inflation also rose by 0.2% from June to July, mirroring the previous month’s increase. Year-over-year, core prices rose by 2.6%, unchanged from last year. Core inflation is often seen as a more reliable indicator of future inflation trends, and the steady figures suggest that inflationary pressures are diminishing.

Friday’s data highlights that inflation is steadily receding in the United States after three challenging years of rapidly rising prices that strained many families’ finances. Inflation peaked at 7.1% in June 2022, the highest in four decades, before gradually declining.

Fed’s Response and Economic Outlook

In a significant speech last week, Fed Chair Jerome Powell attributed the inflation spike in 2021 to a “collision” between supply chain disruptions caused by the pandemic and a surge in consumer demand fueled by federal stimulus payments.

With inflation cooling, Powell announced that “the time has come” to reduce the Fed’s key interest rate. Economists anticipate a reduction of at least a quarter-point at the Fed’s upcoming meeting on September 17-18. Powell also signaled that the Fed is increasingly focused on preventing further deterioration in the job market, as the unemployment rate has risen for four consecutive months.

A decrease in the Fed’s benchmark interest rate is expected to gradually lower borrowing costs for consumers and businesses across various loan types, including mortgages, auto loans, and credit cards.

Ben Ayers, a senior economist at Nationwide, noted in a research report that “the end of the Fed’s inflation fight is coming into view,” adding that the ongoing decline in inflation could give the Fed the flexibility to be more aggressive with rate cuts in upcoming meetings.

Consumer Spending and Economic Growth

The report also indicated that robust consumer spending drives the U.S. economy. Consumer spending rose by 0.5% from June to July, up from a 0.3% increase in the previous month.

Incomes grew by 0.3% in July, outpacing the previous month’s growth. However, with spending increasing faster than income, the savings rate fell to 2.9%, its lowest level since the early months of the pandemic. Ayers cautioned that the decline in savings might lead consumers to cut back on spending soon, potentially slowing economic growth in the coming months.

The Preferred Inflation Gauge

The Fed favors the personal consumption expenditures (PCE) price index, the focus of Friday’s report, over the more widely recognized consumer price index (CPI). The PCE index attempts to account for changes in consumer behavior when prices rise, such as switching from more expensive national brands to cheaper store brands.

Generally, the PCE index shows a lower inflation rate than the CPI. This difference is partly because the CPI gives double the weight to exceptionally high rents compared to the PCE index.

Despite these inflation trends, the U.S. economy continues to expand healthily. The government revised its estimate of economic growth for the April-June quarter to an annual rate of 3%, up from the previous estimate of 2.8%, signaling sustained economic strength.