Key Fed inflation measure rose 0.6% in January, more than expected

A measure the Federal Reserve watches closely to gauge inflation rose more than expected in January, indicating the central bank has more work to do to bring down prices.

The personal consumption expenditures price index excluding food and energy increased 0.6% for the month, and was up 4.7% from a year ago, the Commerce Department reported Friday. Wall Street had been expecting respective readings of 0.5% and 4.4%. The core PCE gains were 0.4% and 4.6% in December.

Including the volatile food and energy components, headline inflation increased 0.6% and 5.4% respectively, compared to 0.2% and 5.3% in December.

Markets fell following the report, with the Dow Jones Industrial Average off around 500 points in morning trading.

“This morning’s strong inflation data continued the recent spate of market-unfriendly news. This could keep the policy rate higher for longer than the market had hoped, which in turn will likely pressure earnings,” said Matt Peron, director of research at Janus Henderson Investors. “While we do see signs that inflation will eventually moderate, higher rates for longer will take a toll.”

Consumer spending also rose more than expected as prices increased, jumping 1.8% for the month vs. the estimate for 1.4%. Adjusted for inflation, prices rose 1.1%.

Personal income adjusted for inflation increased 1.4%, higher than the 1.2% estimate. The personal saving rate also was up, rising to 4.7%.

All of the numbers suggest inflation accelerated to start the new year, putting the Fed in a position where it likely will continue to raise interest rates. The central bank has pushed benchmark rates up by 4.5 percentage points since March 2022 as inflation hit its highest level in some 41 years.

“Clearly, tighter monetary policy has yet to fully impact consumers and shows that the Fed has more work to do in slowing down aggregate demand,” said Jeffrey Roach, chief economist at LPL Financial. “The Fed may still decide to hike by 0.25 [percentage points] at the next meeting, but this report means that the Fed will likely continue hiking into the summer. Markets will likely stay choppy during these months where higher rates have yet to materially cool consumer spending.”

The Fed follows the PCE measures more closely than it does some of the other inflation metrics because the index adjusts for consumer spending habits, such as substituting lower-priced goods for more expensive ones. That provides a more accurate view of the cost of living.

Policymakers tend to focus more on core inflation as they believe it provides a better long-run view of inflation, though the Fed officially tracks headline PCE.

Much of January’s inflation surge came from a 2% rise in energy prices, according to Friday’s report. Food prices increased 0.4%. Goods and services both rose 0.6%.

On an annual basis, food prices rose 11.1%, while energy was up 9.6%.

Earlier Friday, Cleveland Fed President Loretta Mester noted in a CNBC interview that there has been some progress made but “the level of inflation is still too high.”

A nonvoting member of the rate-setting Federal Open Market Committee, Mester has been pushing for more aggressive increases. She said she’s not sure if she’ll again advocate for a half percentage point boost at the March FOMC meeting.

In the wake of Friday’s data, market pricing increased for the likelihood of a half-point, or 50 basis point, increase next month, to about 33%, according to CME Group data.