WASHINGTON — US consumer spending increased by the most in four months in July while services inflation picked up, but economists did not believe strong domestic demand would prevent the Federal Reserve from cutting interest rates next month against a backdrop of softening labor market conditions.
The rise in the costs of services, mostly financial following a stock market rally, sent inflation excluding the volatile food and energy components rising at its fastest pace in five months on a year-on-year basis, the report from the Commerce Department on Friday showed.
Though price pressures from tariffs on imports were mild last month, economists continued to expect the duties to drive up inflation in the second half of the year.
They also anticipate that increasing operating costs for businesses because of tariffs will eventually force employers to lay off workers, putting a damper on their spending.
Consumers, already cutting back on discretionary spending, would also become more selective because of high prices.
The data supports a picture of the US economy that is moving in a more stagflationary direction, albeit slowly,” Preston Caldwell, chief US economist at Morningstar said. “This presents somewhat of a quandary for the Fed, but we expect them to proceed with two rate cuts this year, given that expectations of rate cuts have been baked into the market for some time, and because of worrying data recently in the labor market.”
Consumer spending, which accounts for more than two-thirds of economic activity, rose 0.5 percent last month after gaining 0.4 percent in June, according to the Commerce Department’s Bureau of Economic Analysis. The increase was in line with economists’ expectations.
Motor vehicle purchases led the broad rise in spending, helping to lift outlays on long-lasting manufactured goods by 1.9 percent. There were also increases in spending on recreational goods and vehicles, clothing and footwear as well as furnishings and durable household equipment. Spending on food and beverages rose. But outlays on gasoline and other energy goods declined.
Overall spending on goods increased 0.8 percent after rebounding 0.3 percent in June.
Outlays on services rose 0.4 percent, matching June’s gain, and were lifted by financial services and insurance, healthcare as well as housing and utilities. Spending at
restaurants and bars as well as on hotel and motel rooms fell.”
A consumer that is cutting back on going out to eat and not booking as many hotel stays may not signal disaster, but it does point to the sort of budgeting decisions that households make when under pressure,” Tim Quinlan, a senior economist at Wells Fargo, said. “Persistent moderation in the labor market will make consumers more discerning about where they are willing to spend.”
Businesses have scaled back on hiring, though they have mostly refrained from large-scale layoffs. Employment gains have averaged 35,000 jobs per month over the last three months through July compared to 123,000 during the same period in 2024, the government reported this month.
Stocks on Wall Street fell. The dollar was steady against a basket of currencies. US Treasury yields rose.
INVENTORY DRAWDOWN
Fed Chair Jerome Powell last week signaled a possible rate cut at the US central bank’s September 16-17 policy meeting, in a nod to increasing labor market risks, but also added that inflation remained a threat. The Fed has kept its benchmark overnight interest rate in the 4.25 percent-4.50 percent range since December.
Import duties have been slow to feed through to inflation as businesses are selling stocks accumulated before the sweeping duties kicked in. Businesses have also been absorbing some of the costs. But inventory was drawn down in the second quarter and companies have warned tariffs are raising their costs, which economists expect will eventually be passed on to consumers.
Households are also anticipating higher prices. A separate report from the University of Michigan showed consumers’ one-year inflation expectations jumped to 4.8 percent in August from 4.5 percent in July, with increases among voters who identified as Independents and President Donald Trump’s own Republicans.
For now, inflation is mostly moderate. The Personal Consumption Expenditures (PCE) Price Index increased 0.2 percent last month after rising 0.3 percent in June, the BEA said. Goods prices fell 0.1 percent, pulled down by a 1.7 percent drop in the costs of gasoline and other energy goods. Recreational goods and vehicles prices declined 0.9 percent while the cost of furniture edged up 0.1 percent.
In the 12 months through July, the PCE Price Index advanced 2.6 percent, matching the rise in June.
Stripping out food and energy components, the PCE Price Index increased 0.3 percent after a similar rise in June. Services prices climbed 0.3 percent, the most since February, after rising 0.2 percent for four straight months. They were fueled by a 1.2 percent jump in the costs of financial services and insurance. Housing inflation also rose as did the cost of recreation services.
In the 12 months through July, core PCE inflation advanced 2.9 percent. That was the largest rise since February and followed a 2.8 percent gain in June. The Fed tracks the PCE price measures for its 2 percent inflation target.
“We expect more unwelcome and tariff-induced price inflation to surface in the months ahead,” Scott Anderson, chief US economist at BMO Capital Markets, said.
While the solid consumer spending bodes well for economic growth in the third quarter,
it is drawing in imports, which could blunt some of the boost to gross domestic product.
A third report from the Commerce Department’s Census Bureau showed the goods trade deficit soared 22.1 percent to $103.6 billion last month as imports jumped $18.6 billion to $281.5 billion. Goods exports dipped $0.1 billion to $178.0 billion.
Wild swings in imports because of tariffs led to a contraction in GDP in the first quarter, which was followed by growth snapping back at a 3.3 percent annualized rate in the April-June quarter.
“At face value, the trade data point to a ‘drag’ on third-quarter GDP growth of about 3 percentage points,” Conrad DeQuadros, senior economic advisor at Brean Capital, said.
