With Sticky March PCE Inflation, When Will the Fed Hit Its 2% Target?

The March Personal Consumption Expenditures Price Index posted a stronger-than-expected increase, up 2.7% from year-ago levels, raising more doubts about whether inflation will decline to the Federal Reserve’s target, as well as the timing of interest rate cuts this year.

Analysts had expected the overall PCE Index to rise slightly on a year-over-year basis to 2.6% from 2.5% in February, according to FactSet.

When volatile food and energy costs are factored out, the index increased 2.8% from one year ago, also above expectations. Economists forecast that the core PCE inflation index would rise 2.7%, down slightly from a 2.8% year-over-year increase in February.

The Consumer Price Index report usually overshadows the PCE report, but the PCE is the Fed’s preferred method for tracking inflation. With the CPI showing inflation progress as stalled, the PCE is garnering more attention as central bank officials express dwindling confidence about the potential for inflation to continue its decline toward their 2% target.

“Core PCE inflation has jumped to a 4.4% annualized rate in the last three months, which calls into question whether the economy is still on track to return to the Fed’s 2% inflation target,” says Preston Caldwell, chief US economist at Morningstar. “The inflation data is very volatile, so we shouldn’t be overly surprised by the first quarter uptick in inflation, nor should we take it as a strong indication that inflation will remain similarly high for the rest of 2024.”

Caldwell continues: “Our base case remains that inflation will resume its march to normal over the rest of 2024, with the six-month growth rate posting at around 2% annualized in the second half of 2024. The factors driving the uptick in first quarter 2024 inflation shouldn’t repeat, and the coming fall in housing inflation will provide a further downward impulse.”

He says, ‘Today’s data means it will take a longer string of months of good inflation data before the Fed will be comfortable with cutting. July now seems a bridge too far, unless we see both inflation return to 2% in the coming months and a marked deterioration in economic activity data. However, a September cut is still very likely, contingent on our expectations that inflation returns to 2% over the rest of 2024.”

March PCE Price Index Report Highlights

• The PCE price index rose 0.30% in March vs. a forecast for a 0.30% rise and a 0.33% increase in February.
• Core PCE rose 0.30% in March vs. forecasts of a 0.30% increase and a 0.26% rise in February.
• The PCE Price Index rose 2.7% year over year in March vs. a consensus forecast for a 2.6% increase and a 2.5% rise in February.
• Core PCE rose 2.8% year over year in March vs. a consensus forecast of 2.7% and a 2.8% rise in February

Caldwell notes that durable goods accounted for 0.5 percentage points of the core PCE acceleration in the first quarter. “This is likely a temporary blip,” he says. “Given that supply chains remain in great shape compared with 2021/22, along with slowing consumer goods demand, we should see durables return to deeper deflation in coming months.”

Another contributor was financial services, which accounted for about half a percentage point of the acceleration of core PCE. “The massive 11% rate of financial services inflation in the first quarter is not going to repeat, being greatly driven by the runup in equity prices in the first quarter, which have dropped back in April,” Caldwell says. However, he explains that the rise in healthcare costs “is likely to be more enduring, given that healthcare inflation has lagged the overall price index and is due for a catch-up. We have already factored this into our forecasts.”

At the same time, “more than offsetting a sustained but moderate rise in healthcare inflation in 2024 will be a large drop in housing inflation, in our view,” Caldwell says. “Leading edge data still points strongly to an inevitable fall in housing inflation, even as the exact timing remains somewhat uncertain.”