Fed Contemplates Rate Cuts Amid Steady Inflation and Moderate Consumer Spending

U.S. inflation remained flat in May, while consumer spending rose slightly. This trend might push the Federal Reserve towards cutting interest rates. Inflation has been cooling due to significant rate hikes but remains above the 2% target. Moderate consumer spending and economic growth are also influencing the Fed's monetary policy outlook.

U.S. prices were unchanged in May while consumer spending rose moderately, a trend that could draw the Federal Reserve closer to start cutting interest rates this year. The flat reading in the personal consumption expenditures (PCE) price index last month followed an unrevised 0.3% gain in April, the Commerce Department's Bureau of Economic Analysis said on Friday. In the 12 months through May, the PCE price index increased 2.6% after advancing 2.7% in April.

Economists polled by Reuters had forecast the PCE price index unchanged on the month and rising 2.6% year-on-year. Inflation is receding after spiking in the first quarter as 525 basis points worth of rate hikes from the U.S. central bank since 2022 cool domestic demand. Inflation, however, continues to run above the Fed's 2% target.

Excluding the volatile food and energy components, the PCE price index edged up 0.1% last month. That followed an upwardly revised 0.3% rise in April. The so-called core PCE price index was previously reported to have gained 0.2% in April. Core inflation increased 2.6% year-on-year in May, the smallest advance since March 2021, after rising 2.8% in April. The Fed tracks the PCE price measures for monetary policy. Monthly inflation readings of 0.2% over time are necessary to bring inflation back to target.

The Fed has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range since last July. Though policymakers recently adopted a more hawkish outlook, financial markets expect the Fed to start its easing cycle in September. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased 0.2% last month after rising 0.1% in April, the report also showed. Inflation fatigue, higher borrowing costs, a moderation in wage gains as well as dwindling savings are holding back spending.

Consumer spending slowed sharply in the first quarter, helping to restrict the economy to a 1.4% annualized growth pace. The economy grew at a 3.4% pace in the fourth quarter. Growth estimates for the second quarter are mostly below a 2% rate.