Economy Grew 2% in First Quarter, but Key Inflation Measure Hits a 3-Year High

U.S. economic growth picked up the pace during the first three months of 2026, representing a steady recovery from the previous quarter's pullback—while a key inflation metric closely tracked by the Federal Reserve accelerated.

Together, the indicators released Thursday point to an economy running fairly hot, a trend that will put upward pressure on mortgage rates and reduce the chances of a Fed rate cut anytime soon.

Gross domestic product (GDP), the total monetary value of the nation's goods and services, increased at an annualized rate of 2% from January through March 2025, according to an advance estimate released Thursday by the Commerce Department.

The GDP gains were driven by business investment reflecting an increase in spending on information processing equipment and software amid an ongoing AI boom. Consumer spending, which accounts for roughly two-thirds of economic activity, expanded at a rate of 1.6%, down from last quarter's 1.9%, fueled by health care and financial services.

Meanwhile, nondefense government spending also saw a resurgence, climbing at an annualized rate of 4.4%. This marks a sharp recovery from Q4 2025, when a government shutdown stifled economic growth to just 0.5%, according the commerce Department's final estimate.

A separate economic indicator, the Personal Consumption Expenditures Price (PCE) Index, also released Thursday by the Commerce Department, showed that inflation climbed 3.5% from a year ago.  

The Core PCE index, which strips out volatile energy and food prices, increased at an annual rate of 3.2%, the highest in nearly three years. This metric is the Fed's preferred inflation gauge used by policymakers to evaluate progress toward the central bank's 2% annual price stability target. 

What will the Fed do next?

"There will be a lot more conversations around the halls of the Fed this morning about the worryingly high 3.5% PCE inflation number than the resilient GDP print," says Realtor.com® senior economist Jake Krimmel.

Krimmel points out that both numbers come with caveats: While the U.S.-Iran-related gas price spike may have temporarily inflated PCE, and GDP remains subject to revision, he stresses that only the former threatens the Fed's dual mandate of price stability and maximum employment.

PCE has been well above the central bank's target rate for some time now, and Krimmel says the Federal Open Market Committee (FOMC) is concerned about rising inflation expectations creating a vicious cycle of price increases begetting more price increases.

At yesterday's FOMC meeting in Washington, DC, led by Chair Jerome Powell likely for the last time, participants voted 8-4 to keep federal interest rates at their current range of 3.5%-3.75%. Yet, three of the dissenting voters signaled their discomfort with potential future rate cuts, raising the prospect of an increase.

"In laying the groundwork yesterday, they're setting up a credible threat that the Fed is prepared to take inflation even more seriously than at present should the data get worse," says Krimmel.

Markets currently put the probability of a rate pause extending through the end of 2026 at 84%. Beyond that, a rate hike looks more likely than a cut, according to CME Fedwatch.

Krimmel warns that mortgage rates will not see relief anytime soon. However, he argues that a FOMC and a new Fed chair committed to getting inflation under control is the most important thing for both mortgage rates and consumers in the long-run. 

"Runaway inflation not only hits consumers in the pocketbooks right now, but it also raises the cost of borrowing," concludes the economist.