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US: Core Inflation Holds at Target in July, Real Spending Extends Winning Streak

Personal income rose 0.3% in July – a hair below both market expectations and last month’s gain. Adjusted for inflation and removing taxes, real disposable income was up 0.2% in the month.

Personal spending rose 0.4% in nominal terms, in line with the market expectations. Spending in real terms rose 0.2%, with both services (+0.2%) and goods (+0.2%) contributing to the gain. Within real goods, the gain was driven by nondurables which rose 0.6% on the month, while durables pulled back 0.5%

Core PCE rose 0.2% on the month. Weakness in energy (-0.5%) held back the headline PCE deflator to just 0.1% m/m. In year-over-year terms, the headline PCE index accelerated to 2.3% from 2.2% in the month prior, while the core PCE rose to 2%. The latter has been in the 1.9% to 2% range since March.

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The personal saving rate came in at 6.7%, down only 0.1 of a percentage point from the month prior.

Key Implications

A strong retail sales report had already hinted at a solid gain in consumer spending at the start of the third quarter. Today’s report confirms this to be the case. It’s encouraging to see that the American consumer continues to spend confidently and on a steady basis, with the streak in real spending gains extending to five months as of July.

The second quarter’s 3.8% rebound in consumer spending will be difficult to repeat. Nevertheless, consumer confidence sitting at an 18 year high, along with rising incomes and employment gains all point to a healthy consumer spending growth in the 2½ to 3% range for the second half of the year.

It’s also encouraging to see the Fed’s preferred measure of inflation – core PCE – remaining at or near target on a consistent basis since March. Inflation has indeed firmed over the past few months, but is not getting out of hand. This implies that the Fed should continue on its gradual tightening cycle. A symmetric 2% target as communicated by the Fed, means that even in the event that core inflation breaks somewhat above target, the Fed will still maintain its current policy path. All told, a September hike appears to be in the bag, and is likely to be followed by another hike by year’s end.