[WASHINGTON] US inflation increased less than expected in August and price pressures were more moderate in the prior month than previously reported, likely reducing the urgency for the US Federal Reserve to raise interest rates again in October.

Another rate hike in 2026, however, remains on the table as the report from the US Commerce Department on Wednesday (Sep 30) showed consumer spending surging in August. The economy so far appears to be holding up despite headwinds from the US-Israeli war with Iran, which has raised energy prices. With diesel prices at record highs, economists expected inflation to remain high.

Financial markets knocked down bets for additional policy tightening in October.

“The less-than-feared price data for August may buy the Fed time to await more data and pass on Oct 28, but still-elevated inflation and a resilient consumer and economy point to another rate hike by year-end,” said Sal Guatieri, a senior economist at BMO Capital Markets.

The Personal Consumption Expenditures (PCE) Price Index rose 0.3 per cent in August after a downwardly revised 0.1 per cent gain in July, the Commerce Department’s Bureau of Economic Analysis (BEA) said. Economists polled by Reuters had forecast the PCE price index rising 0.4 per cent after a previously reported 0.2 per cent gain in July.

Inflation over the month was driven by a 4.4 per cent rebound in gasoline prices. Food prices were unchanged.

In the 12 months through August, PCE inflation advanced 3.4 per cent after increasing by a downwardly revised 3.4 per cent in July. PCE inflation was previously reported to have increased 3.7 per cent in July on a year-on-year basis.

The BEA changed its methodology for calculating prices for software and accessories, portfolio management fees and legal services in the PCE price index, accounting for the downgrade to the year-on-year inflation rate.

It also revised the inflation data going back to 2021. Excluding the volatile food and energy components, the PCE price index climbed 0.2 per cent over the month after a downwardly revised 0.1 per cent rise in July. The so-called core PCE inflation was previously estimated to have gained 0.2 per cent in July.

It was in August lifted by a 1.4 per cent jump in the cost of transportation services as well as solid increases in the cost of services at restaurants and bars, and hotel accommodation.

Core PCE inflation increased 3 per cent year-on-year in August after a downwardly revised 3 per cent advance in July. Underlying inflation was initially estimated to have risen 3.3 per cent in the 12 months through July.

Methodology changes lowered core PCE inflation by about 36 basis points, more than the 20-30 basis points that economists had expected. Portfolio management services accounted for the bulk of the downgrade. The US central bank tracks the PCE price measures for its 2 per cent inflation target.

“Two months’ worth of data is not enough to point to a new trend, especially when the monthly reading for August reaccelerated,” said Stephen Stanley, chief US economist at Santander US Capital Markets.

“Nevertheless, there is at least some reason to be a little more optimistic. At a minimum, the Fed can afford to be judicious in hiking and may not need to raise rates by very much to steer inflation down toward target.”

Rate hike expectations dialled back

The Fed in September raised its benchmark overnight interest rate to the 3.75-4 per cent range, the first rate hike in three years, and flagged further increases in borrowing costs in the months ahead.

The odds of an October rate hike were diminished by New York Fed President John Williams’ comments on Tuesday that he saw “no urgency” for further action.

Financial markets priced in a roughly 41.5 per cent chance of a rate increase at the Oct 27-28 meeting, down from 51.5 per cent prior to the data and 70 per cent on Monday, CME’s FedWatch Tool showed. Stocks on Wall Street were trading higher. The US dollar slipped against a basket of currencies. US Treasury yields fell.

Higher inflation and borrowing costs could crimp consumer spending. A survey from the Conference Board on Tuesday showed consumer confidence plummeting to a near 12½-year low in September.

There are, however, no signs yet of consumers dialling back. Consumer spending, which accounts for more than two-thirds of economic activity, surged 0.9 per cent in August after a downwardly revised 0.1 per cent gain in July, the BEA said. Spending was previously estimated to have gained 0.2 per cent in July.

When adjusted for inflation, consumer spending rose 0.6 per cent, keeping it on track to post another robust quarter of growth after rising at a 3.8 per cent annualised rate in the April-June quarter, and helping to drive the economy to a 2.2 per cent growth pace during that period.

Gross domestic product was also supported by business investment related to the buildout of AI infrastructure, with business spending on equipment posting another quarter of double-digit growth.

Consumer spending is also being underpinned by AI-driven stock market gains as well as households tapping into their savings and setting aside less money for a rainy day. Annual revisions to the data showed households had more savings than previously estimated as well as a higher income profile, explaining the resilience in consumer spending.

But income rose a modest 0.2 per cent in August and gained 0.3 per cent after accounting for taxes. Disposable income was flat after adjusting for inflation. The saving rate dropped to 4.1 per cent, the lowest level since November 2022, from 4.6 per cent in July.

“We remain cautious that as real labour incomes slow with higher gas prices, there remain headwinds to spending in coming months,” said Veronica Clark, an economist at Citigroup.

The anticipated boost to GDP growth from strong consumer spending this quarter could be offset by sharply rising imports related to robust domestic demand.

The Commerce Department’s Census Bureau reported that the goods trade deficit increased 11.5 per cent to US$132.6 billion in August, with imports soaring 5.5 per cent to US$336.1 billion. Trade has subtracted from GDP growth for three straight quarters.

“I look for a substantial trade drag of around 2.5 percentage points for the third quarter but, given the strength of demand growth, I still see real GDP growth in excess of 3 per cent,” said John Ryding, chief economic advisor at Brean Capital. REUTERS