Fed holds rates steady as US consumers cut spending, while tariffs and inflation expectations rise
Inflation in the US slowed slightly in January, but consumer spending saw its steepest decline in nearly four years, raising concerns about the country’s economic trajectory.
According to the US Commerce Department, the personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred measure of inflation, increased 0.3 percent for the month and 2.5 percent annually.
The core PCE, which excludes food and energy prices, also rose 0.3 percent in January but showed a reduced annual rate of 2.6 percent, down from 2.9 percent in December.
As reported by Bloomberg, consumer sentiment in the US is shifting, with a growing number of Americans expecting inflation to remain high or even rise.
The University of Michigan’s February survey found that long-run inflation expectations surged to their highest level in nearly three decades.
Bloomberg also noted that consumer confidence fell in February by the most in almost four years, driven by inflation expectations and economic uncertainty tied to US President Donald Trump’s policies, particularly his tariff plans.
While inflation remains a critical concern, US consumer spending declined unexpectedly in January.
Reuters reported that consumer spending, which accounts for more than two-thirds of US economic activity, fell by 0.2 percent after an upwardly revised 0.8 percent increase in December.
The decline was sharper than anticipated, with economists having expected a 0.1 percent increase.
CNN added that when adjusted for inflation, spending dropped by 0.5 percent—the largest monthly decline since February 2021.
Spending on goods, particularly autos and other high-cost items, saw a significant drop, while spending on essentials such as housing and gas remained steady.
CNN noted that factors such as harsh winter weather and auto dealers reducing incentives following a strong December may have contributed to the decline.
Additionally, personal income increased by 0.9 percent in January, yet much of it was saved rather than spent. The US personal savings rate rose to 4.6 percent, according to Commerce Department data.
The inflation report has reinforced expectations that the US Federal Reserve will maintain interest rates in the near term.
CNBC reported that the data aligns with market expectations, keeping US Fed Chair Jerome Powell and other policymakers cautious about rate cuts.
Following the release of the inflation figures, futures traders slightly increased the probability of a quarter-percentage-point rate cut in June to just above 70 percent, as per the CME Group’s FedWatch gauge.
However, the Fed has indicated that it seeks more evidence of inflation sustainably returning to its 2 percent target before lowering rates further.
As reported by Bloomberg, the combination of persistent inflation and slowing economic activity has revived fears of stagflation—a period characterized by both weak growth and high inflation.
Economists remain cautious about drawing conclusions from one month’s data, but if the trend persists, the US Federal Reserve could face a difficult choice between supporting economic growth and continuing its inflation control measures.
Gregory Daco, chief economist at EY, said, “There’s a slight smell in the air of stagflation... but we’re not there yet.”
Trump’s economic policies, particularly tariffs, have added another layer of uncertainty.
Reuters noted that Trump has announced a series of tariff increases, including an additional 10 percent duty on Chinese imports and a 25 percent tariff on Mexican and Canadian goods set to take effect in March.
Businesses have warned that these measures could increase costs and disrupt supply chains.
Ford CEO Jim Farley, cited by Bloomberg, said the proposed tariffs on Canada and Mexico would “blow a hole” in the US auto industry.
The impact of Trump’s policies extends beyond tariffs. According to Reuters, sharp federal spending cuts under his administration have led to job losses among government workers and contractors.
The Fed is also closely monitoring the situation, as policymakers worry that inflation expectations could become entrenched.
Kansas City Fed President Jeff Schmid warned of a “sharp upward” movement in inflation expectations, stating, “I am not willing to take any chances when it comes to maintaining the Fed’s credibility on inflation.”
Despite the uncertainty, some economists expect spending to rebound in the coming months.
CNN cited US Bank’s chief economist, Beth Ann Bovino, who suggested that the recent spending decline may be temporary, given strong labour market conditions and ongoing rebuilding efforts in Los Angeles following destructive wildfires.
She noted, “Spending was much lower than expected; however, it came after pretty strong readings in the prior months—partly tied to holiday spending as well as the rebuild from the hurricanes that happened in October and September.”
For now, the Fed appears likely to hold rates steady at its March meeting. However, as inflation remains above target and economic signals remain mixed, US policymakers face an increasingly complex economic landscape.
