Colder-than-expected numbers on the Fed’s preferred inflation measure ease the urgency of a rate hike

A new reading of the Federal Reserve’s preferred inflation gauge released Wednesday showed prices cooled more than expected in August – and is likely to ease some of the urgency for another interest rate hike next month.

The personal consumption expenditures (PCE) index rose 3.4% in August, less than the 3.7% expected – a level maintained through much of the summer. Excluding volatile energy and food prices, core PCE rose 3%, beating expectations for a 3.3% rise and marking a decline from July’s 3.3%. Month over month, core PCE edged down a tenth of a percentage point to 0.2% from July and beat expectations for a 0.3% rise.

“Fundamental price pressures are slightly weaker than expected and provide some support for our view that the Fed will pause in October,” said Stephen Brown, chief North America economist at Capital Economics.

This cooler reading is partly explained by the fact that the Bureau of Economic Analysis updated its methodology for calculating specific components of the PCE price index, retroactive to 2021.

The BEA has changed the way it calculates inflation in three categories: computer software, legal fees and investment advice. Two of these categories – computer software and investment advice – have seen large price increases over the past year, which some economists say has artificially increased the overall inflation figure.

Brown, of Capital Economics, said the price revisions reduced annual inflation rates for both components affected. Together, he estimates they reduced overall underlying inflation by 0.3%. Downward revisions to price growth in June and July mean that the three-month annualized core inflation rate now stands at precisely 2%.

Before the report was released, New York Fed President John Williams warned against the idea of ​​raising interest rates in October.

Speaking Tuesday in Buffalo, New York, Williams said of the September rate increase that he saw “no emergency need,” and noted that “we have time to gather more information.”

“The accumulation of more data should provide greater clarity on the underlying trends in the economy and the risks associated with achieving our objectives, and therefore on the appropriate setting of monetary policy,” he said.

He forecast another rate hike “at the end of this year” to support what he called a “more timely” return of inflation to 2%. For many, the end of this year means the next Fed meeting is set for December rather than October.

Markets now estimate there is about a 35% chance the Fed will raise interest rates in late October, according to CME Futures, up from 50% on Tuesday after Williams’ speech and about 70% earlier this week.

Not all Fed officials may be convinced that August’s numbers are enough. Fed Governor Michael Barr said Tuesday that he has seen only two months of data consistent with core PCE inflation of 2% over the past 20 months.

“I don’t see a clear trend yet toward a timely return to 2%,” Barr said, although Wednesday’s report would mark a third data point.

Barr said the combined effects of rising energy prices and AI have prevented the Fed from making progress toward meeting its 2% inflation target. He noted that although the effects of tariffs have diminished, energy prices remain high and there is uncertainty over when the effects of the war in Iran on prices can be resolved.

At the same time, he noted that increased investment and demand linked to AI development had a “measurable effect” on prices.

Jennifer Schonberger is a veteran financial journalist who covers markets, economics and investing. At Yahoo Finance, she covers the Federal Reserve, Congress, the White House, Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington politics and finance. Follow her on @Jenniferismes and on Instagram.