US PCE Core Inflation Reaches 1.7%

There was a 0.1% growth in the US Personal Consumption Expenditure (PCE) price index in August after it posted an unchanged figure in July with a year on year rise at 1.0% from the previous value of 0.8%. The core reading which excludes energy and food consumption, which also happens to be the primary focus of the US Fed, reported an increase of 0.2% on the month on the trail of a 0.1% rise in July, on a year on year basis the increase grew from 1.6% to 1.7%. The underlying data was mostly in line with market expectations as the 1.7% annual rate came behind 5 straight readings of 1.6% and was also the highest rate since February.

The core PCE price index is the Federal Reserve’s primary inflation measure with an annual target increase of 2.0% and the index has tended to remain below this level throughout the past four years. The more dovish members of the FOMC will continue to resist higher interest rates while the core reading stays below the 2% level.

The latest reading should, however, increase confidence within the majority of FOMC members that inflation is gradually moving towards the 2% level, which has been a key requirement for the FOMC before removing further monetary accommodation. The data in this context, should slightly bolster expectations of a December tightening move.

The year-over-year inflation rate has been held down by the drop in energy prices last year, but those effects are winding down. Meanwhile, the rising prices of homes, rental units and health care are pushing overall inflation higher. As a result, chief economist Stephen Stanley of Amherst Pierpont Securities predicts the PCE inflation rate will climb to 1.5% at the end of October, the last month of inflation data the Fed will possess when it meets in December. The more closely followed “core” rate is likely to hit 1.8% by year end and perhaps reach 2% earlier next year.

“The rising tide of inflation is the main reason that I believe the [Fed] will actually follow through and raise rates in December, even as it has lost its nerve a handful of times over the past 18 months,” he wrote in a note Friday.

There is still a chance, of course, inflation will level off or even decline as it’s done frequently in recent years. Food prices, for one thing, have tumbled after several years of elevated costs. And the higher cost of housing could cause home buyers to back off or renters to seek cheaper options. Oil prices could even backslide, especially if OPEC fails to cut production.

At this point, though, it looks like inflation will rise just enough to give Fed officials justification to raise rates in December.

“Inflationary pressures should continue to build gradually, allowing the Federal Reserve to pursue a cautious and drawn-out monetary tightening cycle in coming years,” assert economists at Nationwide.

The dollar was unable to gain any support from the data with EUR/USD at 1.1175 after finding support ahead of 1.1150. Treasuries were still in positive territory by around 4 ticks as risk conditions dominated with equity futures little changed ahead of the open.