Fed's favored inflation gauge holds at 3.7% as households pull back on goods spending

The Federal Reserve's preferred inflation gauge held at an elevated 3.7 percent in July, the Commerce Department reported Wednesday, as American households continued to divert spending away from goods and toward services — a shift economists say reflects both stretched budgets and the lingering bite of tariffs and elevated energy prices.

The Personal Income and Outlays report, published by the Bureau of Economic Analysis, showed the personal consumption expenditures (PCE) price index rose 0.2 percent for the month, leaving the annual rate unchanged at 3.7 percent. Core PCE — which strips out volatile food and energy costs and is the metric Fed officials watch most closely — also rose 0.2 percent on the month and held at 3.3 percent year-over-year, nearly double the central bank's 2 percent target.

The numbers

Beneath the headline inflation figures, the report showed a household sector that is still spending but doing so more cautiously and unevenly. Personal income climbed $115.1 billion, or 0.4 percent, in July — stronger than the 0.3 percent economists had forecast — while disposable personal income, the amount left after taxes, rose 0.5 percent. Overall consumer spending increased a more modest $36.3 billion, or 0.2 percent.

• PCE price index: +0.2% month-over-month; +3.7% year-over-year
• Core PCE price index: +0.2% month-over-month; +3.3% year-over-year
• Personal income: +0.4% ($115.1 billion)
• Personal saving rate: 3.0%, up from 2.7% in June

The composition of that spending is where the report tells its most striking story. Services spending rose $86.2 billion in July, while spending on goods — everything from appliances to clothing to electronics — fell $49.9 billion. Adjusted for inflation, real consumer spending was essentially flat, rising less than 0.1 percent. The BEA's price index data shows the goods pullback concentrated in categories most exposed to import costs, consistent with tariff pass-through that economists have been tracking since early in the year.

The personal saving rate, meanwhile, ticked up to 3.0 percent from a downwardly revised 2.7 percent in June — a small but notable reversal after months of savings erosion, as income growth outpaced spending growth for the first time since spring.

Context: inflation stuck above target

Wednesday's reading extends a run of PCE inflation sitting well above the Fed's 2 percent goal that has now stretched past five years. Historical data tracked by the St. Louis Fed's price-index series shows the index has not touched target on a sustained basis since before the pandemic-era surge, and July's reading came in a tenth of a point hotter than the consensus forecast of 3.6 percent that economists surveyed by Dow Jones had projected.

Part of the pressure is coming from energy. Gasoline prices near $4 a gallon nationally and diesel above $5.60 — elevated in part by disruptions tied to the conflict with Iran — have squeezed household budgets even as core goods prices show some tariff-driven stickiness. That combination has left the inflation picture more complicated than a simple headline-versus-core comparison: goods spending is falling not because prices are dropping, but because higher prices are pricing some purchases out of household budgets altogether.

Who is affected

The income and spending data point to a widening divide in how the slowdown is being felt. Economists who track household-level spending patterns have noted that gains in overall consumption have been driven disproportionately by higher-income households, while spending among lower- and middle-income households has largely stagnated once adjusted for inflation. Because tariffs function as a regressive tax — falling hardest on households that spend a larger share of their budget on imported goods — the goods-spending pullback registered in July's report is expected to weigh more heavily on lower-income families than on affluent ones.

Retirees and other households living on fixed or near-fixed incomes face a related squeeze: even as the topline saving rate improved, a 3.7 percent annual inflation rate continues to erode purchasing power faster than most wage and benefit adjustments are built to absorb. Renters and homeowners with adjustable costs, along with anyone financing large purchases, remain exposed to a rate environment the Federal Reserve has so far been reluctant to ease given inflation's persistence.

Reaction

The reading drew a cautious response from economists who had hoped for clearer signs of cooling.

"The United States still has an inflation problem. PCE inflation came in hotter than expected," said Heather Long, chief economist at Navy Federal Credit Union, pointing to gasoline prices near $4 a gallon and diesel above $5.60 as evidence that energy costs tied to the Iran conflict are still working through household budgets.

Bret Kenwell, U.S. investment analyst at eToro, framed the report as raising the stakes for the Federal Reserve's leadership. "The challenge is becoming increasingly clear: inflation is still too high for comfort, and investors will be watching to see whether Fed Chair Kevin Warsh uses Friday's Jackson Hole speech to address how policymakers plan to bring it back toward the Fed's long-term target," Kenwell said.

What happens next

The report lands three days before Fed Chair Kevin Warsh delivers his first Jackson Hole keynote address since taking over the central bank, part of the annual Jackson Hole Economic Symposium hosted by the Kansas City Fed on Friday. Markets are watching closely for any signal on how the Federal Open Market Committee will weigh Wednesday's data ahead of its next scheduled meeting on September 15–16, where traders are currently pricing roughly even odds of a policy move.

Households, meanwhile, are left navigating a stretch where prices are rising faster than the Fed would like but spending power is not collapsing outright — a combination that economists say is likely to keep discretionary goods purchases under pressure into the fall, even as services spending, from health care to travel to dining, continues to absorb a growing share of the household budget.