The new PCE reading supports the case for a smaller Fed rate cut in November

A fresh reading on inflation on Friday keeps the Federal Reserve on track to continue cutting interest rates this fall, likely in 25 basis point increments.

The Fed’s preferred gauge of inflation — the core personal consumption expenditures (PCE) index that excludes volatile food and energy prices — rose 2.7 percent from a year earlier in August.

That was in line with expectations and up a tenth of a percentage point from 2.6% in July. It remains above the Fed’s 2% target.

The result means a cut of more than 50 basis points may be hard to justify at the Fed’s next meeting in November, according to some Fed watchers.

The fact that year-over-year core inflation is holding the level of the past two months and not falling, aligns more with a scenario for a smaller cut — lest the labor market weaken substantially between now and November.

“The year-over-year basis of 2.7% suggests another round of 50 basis points needs to be looked at carefully unless the labor market suggests weakness,” said Quincy Krosby, global chief strategist for LPL Financial.

Measured month-over-month, PCE looked even better. That measure rose just 0.1 percent compared with expectations for 0.2 percent and fell from 0.2 percent in July and June.

When food and gas prices are added back in, PCE rose 2.2 percent in August—just two-tenths of a mile away from the Fed’s 2 percent inflation target. That was lower than estimates of 2.3 percent and down from 2.5 percent in July.

“Fed officials feel pretty good about where inflation is,” said Pimco Managing Director Tiffany Wilding, who predicts two more 25-basis-point cuts in November and December.

However, investors are still divided on whether the Fed will cut from 25 basis points or 50 basis points at its next policy meeting in November. The odds of a bigger cut rose slightly to 54% after the PCE data was released.

The consensus among Fed officials outlined last week is for two more 25 basis point rate cuts in 2024.

They made the prediction as they approved another 50 basis point rate cut, the first such cut since 2020, citing confidence that inflation is easing and evidence that the labor market is cooling.

Read more: What Fed rate cuts mean for bank accounts, CDs, loans and credit cards

Economists at accounting firm EY said in a note on Friday that “we still expect the Fed to ease policy by 25 bps at each meeting through June next year.”

That outlook could change, added EY senior economist Lydia Boussour and EY chief economist Gregory Daco, if “labor market conditions deteriorate further.”

The story continues

“we’re close”

Fed Chairman Jerome Powell and other officials have made it clear that the Fed has not yet declared victory over inflation.

“We’re close, but we’re not really at 2%, and I think we’re going to want to see it around 2% and close to 2% for a while. … We’re not saying mission accomplished,” Powell said last week.

Fed Governor Adriana Kugler said this week that if core PCE reached 2.7%, that would be “consistent with ongoing progress toward the FOMC’s 2% target,” meaning the current path for two cuts of less than 25 basis points would be in line. with the current rate cut path.

Atlanta Fed President Raphael Bostic also said his concern about inflation not yet hitting the Fed’s 2 percent target is keeping him from tapering further.

Fed Governor Michelle Bowman, who dissented at the last policy meeting because she would have preferred to cut by 25 basis points instead of 50 basis points, is still more worried about inflation than her colleagues.

Bowman said he sees “higher risks to price stability, especially while the labor market continues to be close to full employment estimates.”

Read more: How does the labor market affect inflation?

Core inflation, according to Bowman, is uncomfortably high and upside risks to inflation remain prominent given high government spending and the fact that global supply chains remain susceptible to labor strikes and geopolitics.

On the other hand, Minneapolis Fed President Neel Kashkari said this week that he did not see much evidence that inflation could surprise higher, pointing to wages and core prices of non-housing services continuing to fall.

“While the Fed can’t declare complete victory over inflation, today’s report — up 2.2% on the headline year-over-year — underscores that headline inflation continues to move decisively in the right direction,” LPL Financial’s Krosby said.

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