Photo by Allef Vinicius via Unsplash.
Prices are rising and Americans are spending more again, suggesting that the economy is still strong and the Fed might have to raise borrowing costs more to halt the inflation spike.
Friday’s report from the Commerce Department showed that consumer income grew by 0.6 percent in January and spending increased by 1.8 percent. The Personal Consumption Expenditures price index, which the Federal Reserve and market participants prefer to use for measuring inflation, have risen by 0.6 percent compared to December and by 5.4 percent from a year ago.
After removing prices of volatile food and energy from the data, or the Core Personal Consumption expenditures price index, still grew by 4.7 percent, an unexpectedly high number for the economists who had made estimates. The Fed’s goal of inflation rate is 2 percent.
Even though the Fed has been trying to tame inflation and cool down the economy by raising borrowing costs, consumers are still spending, the labor market is tight and the economy is still strong. This might lead the Fed to increase the current 4.75 percent interest rate by more than 25 basis points, which had been the economists’ anticipation. The Fed hopes higher borrowing costs will ease spending by businesses and consumers and deliver a slower economy without recession.
“Not only did January start more strongly than people expected, including ourselves, but the fourth quarter was also revised higher,” said Kevin Cummins, chief US economist at Natwest Markets. “This probably implies that the Fed still has more work to do.”
At the same time, the report from December that suggested inflation was showing signs of moderation, have been revised, showing that the inflation actually decelerated at a slower pace than initially estimated.
Friday’s report showed that in January, consumer spending increased by 1.1 percent, mostly reflecting demand on mostly food services, and goods such as motor vehicles.
Income increased by 0.6 percent, including 0.9 percent higher wages and salaries. Disposable personal Income, which represents households’ actual purchasing power and is basically money left after taxes, has also increased since December, keeping up with the growing trend throughout the last seven months.
“I think overall, when you cut through some of the noise and the data, it suggests that consumers are remaining quite resilient,” said Shannon Seery, the vice president and economist for Wells Fargo's Corporate and Investment Bank.
Friday’s report solidifies earlier indicators this year that show the economy is still strong and consumers are still spending, amid fears of recession. Earlier this month the Labor Department reported the lowest unemployment rate of 3.4 since 1969 and according to the U.S. Census Bureau’s data from January, retail sales, or spending on food or shopping, have also unexpectedly increased compared to the end of 2022.
Growing real wages and low unemployment has been a favorable trend for households. But higher salaries and increased spending have in large measure offset higher inflation.
All this means that the Fed might increase interest rates more than people expect, because the previous rate spikes have yet to slow the economy.
“The downside of all of this is that it might put more pressure on the Fed if these wage gains do translate into inflation getting stuck on the way back down to 2 percent,” Shannon Seery said.