Service sector inflation warms

February 29, 2024

The personal consumption expenditures index, the Federal Reserve's official target, rose 0.3% in January, buoyed by increases in service sector prices, notably for financial services and health care, despite a continued easing of goods prices. The overall index rose only 2.4% from a year ago, after rising 2.6% last month. That is getting closer to the Fed’s 2% target.

However, the Fed remains concerned that the low hanging fruit from the drop in goods sector prices due to a healing of supply chains has been plucked. That means we need to see more cooling in service sector inflation to ensure that the Fed not only achieves its 2% inflation target but that inflation stays there. The goal is to eradicate inflation as a factor distorting household and firm spending decisions.

The core PCE, which excludes the volatile food and energy components, rose 0.4% in January, which marks a sharp acceleration over last month’s 0.1% increase. Core PCE rose 2.8% from a year ago, down only slightly from the 2.9% annual gain in December.

The super core services component of the PCE jumped 0.6% in January, more than double the 0.25% pace of December. The index rose 3.5% from a year ago, up from the 3.4% pace of December. A portion of that increase was due to an acceleration in the cost of financial services fees that reflects higher interest rates. That is less worrisome to the Fed than the acceleration in food and accommodation services. Healthcare costs are also rising as are the backlogs to see doctors.

Insurance costs were unchanged in the index for the month. Those costs are measured differently than their counterpart in the CPI, which accelerated sharply in January.

Personal incomes jumped 1% in January, the strongest monthly gain in incomes since January 2023. The 3.2% cost of living adjustment for Social Security recipients, who swelled to 71 million, drove the outsized gain. That added to the 0.4% gain in wages and salaries for the month.

Personal disposable incomes were unchanged after adjusting for inflation. That marks a slowdown from the pace of December. The revisions to November and December were marginal.

Personal consumption expenditures fell 0.1% during the month after adjusting for inflation. That comes on the heels of upward revisions to November and December. Unusually bad winter weather took a toll on spending, notably goods during the month; vehicle sales were particularly weak. Service sector spending, which covers everything from eating out to travel and health care, held up better. The saving rate edged up slightly, which should buoy spending later in the quarter.