July PCE Inflation Report: Fed's Preferred Gauge Rises

The July Personal Consumption Expenditures (PCE) Price Index rose 2.5% year-over-year, coming in slightly below economists' expectations of a 2.6% increase. This softer inflation reading has bolstered expectations that the Federal Reserve may lower interest rates in September.

Excluding the more volatile categories of food and energy, the core PCE index, which is the Fed’s preferred inflation measure, rose 2.6% from the previous year, also below the forecasted 2.7%.

On a month-over-month basis, the PCE Price Index increased by 0.2%, with the core index—excluding food and energy—also up 0.2%.

July PCE Inflation Report Highlights

1. The PCE Price Index increased by 0.2% in July, matching the FactSet consensus estimate and building on June’s 0.1% rise.
2. Similarly, core PCE, which excludes food and energy, also rose 0.2% in July, consistent with forecasts and repeating the same increase from the previous month.
3. On a year-over-year basis, the PCE Price Index climbed 2.5% in July, slightly below the expected 2.6% rise, mirroring the increase from June. Core PCE rose 2.6% year-over-year, also falling short of the 2.7% forecast but matching the previous month's gain.

Caldwell notes that some factors contributing to the recent decline in inflation may not continue to have the same impact. "Airline prices dropped 13% on an annualized basis due to lower jet fuel costs and strong competition, but that’s unlikely to be repeated," he explains. "However, we’re also witnessing a broader reduction in inflation within the services sector, which can be sustained as wage growth slows, after having been unusually high."

In this context, the Federal Reserve is expected to reduce its target interest rate, currently between 5.25%-5.50%. The question is by how much. "With inflation returning to more normal levels, there’s little justification for maintaining highly restrictive rates, which could risk pushing the economy into a recession," Caldwell says. "At the same time, today’s data on real consumption growth shows there’s no immediate crisis, so there’s no need for aggressive 50-basis-point cuts at each meeting, as some have speculated. The recent uptick in unemployment is concerning but appears to be an outlier in otherwise strong economic data."

Inflation Is on Track

The July inflation data, released Friday morning, indicated that price growth is continuing to trend toward the Federal Reserve's 2% target, strengthening the case for interest rate cuts next month.

Both the overall PCE price index and the core index, which excludes volatile food and energy costs, increased by 0.2% in July. This subdued price growth extends the recent trend of softer inflation readings, aligning with what Fed officials have been aiming for before relaxing their restrictive monetary policy.

How will the PCE affect EUR/USD?

The US Dollar is hovering near yearly lows against its major counterparts ahead of the release of the Federal Reserve's preferred inflation gauge. This downward trend has pushed the EUR/USD pair to its highest level in thirteen months, approaching 1.1200.

Markets have largely priced in a Fed rate cut in September, with a 25 basis point (bps) reduction seen as more likely than a 50 bps move.

If the July core or headline PCE inflation reading exceeds expectations, the US Dollar could see a rebound, as such data would dampen recent forecasts for aggressive Fed rate cuts this year. This could lead to a correction in the EUR/USD pair from its one-year highs. Conversely, if the core figures show slower-than-expected growth, the Dollar may face renewed selling pressure, driving the EUR/USD higher.

The immediate market reaction to the PCE report may be muted, however, as traders adjust positions ahead of next week's key US employment data.

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