US PCE inflation falls to 3%, lowest level in 2 years

29 Jul 2023 , 08:02 AM

Every month, the US announces two different types of inflation number from a consumer perspective. This is distinct from the producer inflation which is also announced. The first type of consumer inflation is the CPI inflation, which is announced around the middle of each month for the previous month. The second type of consumer inflation is based on personal consumption expenditures (PCE) and is also referred to as PCE inflation. The PCE inflation is normally announced towards the end of the month for the previous month. For the month of June 2023, the PCE inflation was announced on July 28, 2023. The PCE inflation fell to 3% in the month of June 2023 on a yoy basis.

PCE inflation for June 2023 falls to 2 year low

The PCE inflation for the month of June 2023 came in sharply lower at 3% and is now on par with the CPI inflation. The table below captures the PCE yoy inflation over the last 5 months.

Month	Headline PCE Inflation	Core PCE Inflation
February 2023	5.0%	4.7%
March 2023	4.2%	4.6%
April 2023	4.3%	4.6%
May 2023	3.5%	4.6%
June 2023	3.0%	4.1%

Data Source: Bureau of Economic Analysis (US)

Like in the case of CPI inflation, the PCE inflation is also expressed as headline inflation and the core inflation. The core inflation is the residual PCE inflation that is shorn of food and fuel, which tend to be more volatile and cyclical in nature. The headline inflation is a combination of food inflation, fuel inflation and the structural core inflation.

Clearly, the headline PCE inflation has fallen from a high of 5% to 3% between February 2023 and June 2023. But what is more gratifying is that the core PCE inflation which had been static at around 4.6% for the last 3 months has fallen by 50 bps to 4.1%. PCE inflation is different from the CPI inflation in that the former focused more on consumption expenditure on various items rather than just the prices. Hence it is an index of price pressure as well as the trends in consumer spending. That is why the Fed uses the PCE inflation as its benchmark for taking decisions on the Fed rates.

 

What we read from the PCE inflation report

It must be remembered that while the CPI inflation in the US is put out by the US Bureau of Labour Statistics (BLS), the PCE inflation is put out by the US Bureau of Economic Analysis (BEA). Here are some of the key inferences we took away from the PCE inflation report for the month of June 2023.

1. For the month of June 2023, the headline inflation fell to 3.0% while the core PCE inflation fell to 4.1%. This is the first real fall in core PCE inflation in the last few months. The eventual target for the Fed is to take the headline PCE inflation and the core PCE inflation towards the target of 2%. It is at this point that the Fed would believe that the intent behind the hawkishness would be fully achieved. 

    

2. The PCE inflation cooling, combined with CPI inflation also cooling is a clear indication that the inflation pressures in the economy are reducing. The third ratification came from the GDP data announced for Q2 yesterday. The first advance estimate showed GDP for Q2 growing at 2.4%. What is more gratifying is that this is despite lower nominal inflation and entirely driven by a sharp fall in inflation.

    

3. If you break up the items in PCE inflation, the picture is fairly mixed. For instance, the dichotomy between goods and services continues. For instance, the goods prices actually decreased by 0.1% for the month of June 2023 while the prices of services rose by 0.3% for the month. Food prices also fell 0.1% for June 2023, while energy increased 0.6% and this could be attributed to the gradual waning away of the base effect.

    

4. Personal income increased by $69.5 billion (0.3% monthly) in June 2023. For the month of June 2023, the disposable personal income (DPI), which is the personal income less personal current taxes, increased by $67.5 billion (0.3% monthly) while the personal consumption expenditures (PCE) increased by $100.4 billion (0.5%) for the month of June 2023. The increase in personal income in June reflects higher compensation; but was partially offset by lower personal income receipts on assets.
5. Let us look at the break-up of the $100.4 billion spike in current-dollar PCE in June 2023. This constitutes $51.2 billion rise in spending for services and $49.1 billion higher spending for goods. Within the gamut of services, the major contributors to the spike were financial services, insurance, portfolio management and investment advisory; apart from housing and utilities. Under goods, the spike came from motor vehicles and parts as well as gasoline and other energy goods.

    

6. The latest PCE broadly confirms the macro narrative that inflation is cooling and economic growth is continuing. This is a rather favourable environment for risk assets as well as for the risk-on emerging markets like India. Ideally, the Fed should take comfort from the fact that the inflation threat is dissipating and the Fed may now be able to think of an extended pause with respect to future interest rate increases.

    

7. As we had stated earlier, this is a dual ratification that inflation is coming under control even while ensuring a soft landing for the markets. It shows that compared to the soaring inflation about a year ago, prices have begun to ease. This is not only ratified by the consumer inflation announced but also the real GDP for the second quarter, where the first advance estimates have seen real GDP being boosted by low inflation.

    

8. The data also hints that the US economy may just about manage a soft landing rather than the fears of recession that most sceptics had expressed a few months ago. This is underlined by the fact that personal income rose 0.3% while spending increased by 0.5%. While incomes were impacted, the spending was not. Considering the Fed had already pre-emptively hiked rates by 25 bps in July to the range of 5.25%-5.50%, there is a pause for a prolonged pause by the rates. Whether, this results in the end of the rate hike cycle, remains to be seen.

What are the takeaways for the Fed and for India?

In the July Fed policy statement, the Fed was fairly explicit that the future rate action would be driven by data and data alone. Clearly, the data from multiple fronts like PCE inflation, CPI inflation and even GDP growth in real terms is indicating that inflation is rapidly coming under control and moving towards the 2% target of the Fed. Unless there is a sharp upturn in fuel prices or some major geopolitical disruption, the probability of another sharp spike inflation has sharply receded. While it is too early to celebrate, the latest PCE inflation data raises the probability of the US pausing in the next few Fed meetings. But, what does this mean for India?

For India, there are three major imperatives. Firstly, there is the positive side to the story. The RBI had silently shifted out of inflation focus into growth focus with the sole assumption that the lag effect of rate hikes should work. That actually turned out to be true and inflation has come down sharply despite the pause in rate hike. That means that the RBI can continue to focus on its growth agenda and let the market forces now take care of inflation. Secondly, there is a concern that the US may be getting closer to the inflation target while the Indian economy just went farther in June. India has to specifically focus on food and fuel, where the biggest upsides to inflation exist.

Finally, what would really please the RBI and the Indian government is that it looks very likely that the US may manage a soft landing. A hard landing in the US would have larger implications for Indian goods and services trade. In fact, that was already visible in the last few months. If the US consumption and spending remains robust, it is good news for India, for whom the US is still the largest trade partner, and more importantly the largest export destination. The latest PCE inflation just reinforces the feel-good factor at a macro level.