Inflation Accelerated From August
- There were modest increases in nominal household income and consumer spending in August.
- Overall inflation slowed in August but remains much higher than the Federal Reserve would like.
- Inflation-adjusted after-tax income and consumer spending both rose in August.
- Consumer spending continues to raise, but the drivers are turning less positive.
- The Fed will continue to raise interest rates in the near term to slow inflation.
- The most likely outcome is modest economic growth in 2023, but recession risks are elevated.
Nominal personal income rose 0.3% in August from July, with after-tax income up 0.4%. Wages and salaries increased 0.3% over the month due to more jobs and higher pay. After-tax income growth was 0.3% in July, and 0.6% in both May and June.
Nominal consumer spending increased by 0.4%. Household goods spending fell 0.5%, including a 0.8% decline in spending on nondurable goods as gasoline prices fell. Spending on durable goods rose 0.1%, and spending on services was up a strong 0.8%. PCE fell 0.2% in July, but rose 0.7% in May and 1.2% in June. Rising gasoline prices in the spring and early summer, and then a big drop since, have driven large swings in nominal consumer spending in recent months.
With after-tax income and consumer spending both up equally, the saving rate held steady at 3.5% in August from July. This is much lower than it was last year at this time, but is up from 3.0% in June, when high gasoline prices led to a big drop in saving.
The personal consumption expenditures price index rose 0.3% in August, after falling 0.1% in July. The core PCE price index, excluding food and energy prices, rose a strong 0.6% in August; it was flat in July. Core inflation tends to be “sticky,” so the acceleration in August is a concern for the Federal Reserve.
On a year-ago basis over PCE inflation was 6.2% in August, a slowing from 6.4% in July and 7.0% in June. The core PCE price index was up 4.9% in August, up from 4.7% in July, but down slightly from 5.0% in June. The PCE price indices are the Federal Reserve’s preferred inflation measures, and both overall and core inflation are far above the central bank’s 2% objective.
Real (inflation-adjusted) after-tax income was up 0.1% in August, as was real consumer spending.
This release included the annual revisions to the income, spending, and inflation data. There were big upward revisions to personal income in 2019 through 2021. But personal income growth in 2022 has been revised lower. In particular, the personal saving rate has been revised much lower this year. In July, before the revisions, the personal saving rate was 5.0%; with revisions, the July saving rate is now 3.5% (same as August).
The consumer spending and income report for August was a mixed bag. Incomes and consumer spending are both rising, but modestly. Consumers got some relief over the month from the ongoing decline in gasoline prices, but high inflation in other parts of the economy is a drag. Even with high inflation, however, real household incomes and spending are increasing in 2022, but at a much slower pace compared to last year.
The biggest positive for consumer incomes and spending in the fall of 2022 is the very strong labor market. Job growth remains good and the labor market is tight, pushing up wages. That is enough to support modest gains in after-inflation incomes and consumer spending, especially now that gasoline prices are down by about $1 per gallon from their peak in the summer. Consumer spending growth is shifting from goods to services. Households bought a lot of goods in the initial recovery from the pandemic, but are now more interested in purchasing services as the economy continues to reopen; high goods inflation is also a drag on goods spending.
But the headwinds to household income and spending are increasing. Most notable is high inflation. Additionally, household wealth has taken a hit from the declining stock market, and soon falling house prices will become an additional drag on wealth and spending. Higher interest rates are weighing on the housing market and associated purchases. Job growth is set to slow in 2023 as Fed interest rate hikes take a toll on the economy.
One reason that households have been able to maintain their spending, even with high inflation, is that they still have a lot of money saved up from earlier in the pandemic, when there was income support from the federal government and limited opportunities to spend. Aggregate household savings is still high, although some households have gone through their savings with high inflation. And with revisions, the saving rate in 2022 was lower than initially thought, indicating that households may have less of a savings cushion.
The most likely outcome is that household incomes and spending continue to rise modestly, and the economy is able to avoid recession. But consumers will face difficult times in 2023, and they could pull back on their spending as the labor market softens, pushing the overall economy into recession. PNC puts the probability of recession in 2023 at around 45%, about double what it was prior to the Russian invasion of Ukraine.
There were upward revisions to inflation in recent months, and that creates more problems for the Federal Reserve. The central bank has been aggressively raising interest rates in an effort to slow growth and push down inflation, and that process will continue through the rest of this year and into 2023. The Fed’s key policy rate, the fed funds rate, started the year at essentially 0% and is now above 3%, and will likely end this year at above 4%. With inflation remaining high, particularly core inflation, the Fed could easily overdo it, raising rates to a level that pushes the economy into recession sometime next year.
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