The Fed’s Favorite Inflation Metric Just Hit 3%—Cooling Urgency for Rate Hike

A key inflation gauge closely tracked by the Federal Reserve cooled more than anticipated last month even as consumer spending rose, casting doubt on further interest rate hikes this year.  

The core Personal Consumption Expenditures (PCE) index, which strips out volatile food and energy prices, rose 3% in August compared to a year ago and was up 0.2% month over month, the Department of Commerce reported Wednesday.

Both figures were lower than economists' forecasts of 3.3% and 0.3%, respectively.

Central bank's policymakers monitor core PCE to assess progress toward the Fed's 2% annual inflation target.

Meanwhile, headline PCE index measuring overall consumer prices increased 0.3% in August from July and was up 3.4% compared to last year, also coming in below economists' predictions.

Despite rising prices, Americans went on a buying spree in August. Inflation-adjusted spending surged 0.6% in August, up from 0.1% in July, marking the fastest month-over-month acceleration since March 2025.

What this means for the Fed

Financial markets rallied Wednesday in response to the better-than-anticipated PCE print, dialing back expectations for a second interest rate increase this year.

Bond markets currently put the probability of the federal funds rate remaining at its current 3.75%-4% range at the next Federal Open Market Committee (FOMC) meeting in October at just over 65%, according to CME Fedwatch.

The odds shifted down Tuesday after New York Fed President John Williams made comments implying that he still favors one additional hike this year, but he sees "no need for urgency."

In September, the Fed raised its overnight benchmark rate by a quarter-percentage point for the first time in three years to curb inflation. Most economists still anticipate at least one more hike by the end of December.

The Fed uses higher interest rates to combat inflation, and lower rates to stimulate the economy and ensure maximum employment in line with its dual congressional mandate. 

Recent indicators

In August, inflation as measured by the Labor Department's higher-profile Consumer Price Index (CPI) rose 3.4% annually, unchanged from July, while core CPI, which excludes food and energy prices, ticked down to 2.4%.

Meanwhile, nonfarm payrolls last month rebounded with 162,000 jobs added, representing a major turnaround following two disappointing reports in June and July. 

Realtor.com® senior economist Jake Krimmel says while the latest PCE readout comes as welcome news, he expects the Fed to remain vigilant. Chairman Kevin Warsh has repeatedly stressed that he is more concerned with trends rather than single data points.

"My expectation is that the Fed will still hike again this year, but perhaps today's favorable print, which is backward looking, we must remember, might give them a little breathing room to wait and see in October," concludes Krimmel.