Consumers Continue to Spend as Inflation Edges Higher

Consumer spending rose 0.2% after adjusting for inflation in July, the same as real disposable income. The pace of spending and income gains both slowed from the torrid pace of the second quarter, on an inflation-adjusted basis. That was to be expected as consumers continued to catch up after hibernating during the first quarter. It affirms our forecast for a slowdown in the overall pace of economic growth in the third quarter.

The saving rate slipped to 6.7% from 6.8% in June. That suggests consumers mostly spent what they earned instead of taking on debt to make purchases last month.

Consumers continued to spend on discretionary services including restaurants and hotels. We also saw a spurt in spending for prescription drugs. Big-ticket durable goods, like vehicles, fell in July, after adjusting for inflation.

The personal consumption expenditures (PCE) deflator (one of the most accurate inflation measures) edged up 0.1% in July despite a drop in energy prices (mostly at the gas pump), which partially offset increases in services and big-ticket items. The PCE rose 2.3% from one year ago, close to the pace of June. The effects of higher tariffs on steel and aluminum imports have started to show up in prices for big-ticket durable goods. Services prices also rose. We will closely monitor the service component for increases in airfare and transportation costs in the August data, given recent announcements by the airlines. This reflects a pick-up in demand for travel, especially among business travelers who benefited the most from lower prices.

The PCE deflator excluding the volatile food and energy components increased at a slightly faster 0.2% pace, up 2% on a year-over-year basis. That marks the third time this year that the core PCE measure has reached he Federal Reserve’s inflation target and will provide justification for the Federal Open Market Committee (FOMC) to raise short-term interest rates again in September. The Fed uses rate increases as a way to remove excess accommodation. It will not be long, however, before rate hikes move from benign to biting.

Bottom Line
Consumers continued to earn and spend at a decent pace in July, but momentum slowed a bit from the second quarter. Our forecast has real GDP growth coming in at close to a 3% pace in the third quarter following a revised 4.2% during the second quarter.

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