US consumer spending rebounded in February, but core inflation remained stubbornly high, complicating the Federal Reserve’s outlook on interest rates.
The Commerce Department reported on Friday that the personal consumption expenditures (PCE) price index rose 0.3% for the month, keeping the annual rate at 2.5%. However, the core PCE index, which excludes food and energy, climbed 0.4% month-over-month and 2.8% from a year earlier, slightly exceeding expectations.
Bill Adams, chief economist at Comerica Bank, noted the data points to a cooling economy.
"The February spending data confirm a slowdown in consumer activity in the first quarter of 2025," Adams said. "Weak spending in January could be attributed to one-off drags from the LA wildfires and bad weather, but February’s anemic rebound points to a more persistent drag."
Personal income grew a stronger-than-expected 0.8%, largely due to a 2.2% rise in personal current transfer receipts, while wages and salaries increased by a more modest 0.4%. Real personal consumption expenditures rose 0.4%, led by a 1.4% increase in durable goods spending, though spending on services was weak, declining 0.1% in real terms—the first such drop since January 2022.
Jeffrey Roach, chief economist at LPL Financial, described the report as “a bit of a disappointment.” He highlighted that core inflation "rose 0.37% month over month in February, the hottest monthly rate in over a year," while also noting that spending on restaurants and hotels saw "the most significant decline in over two years, signaling weakening discretionary spending."
Fed's balancing act
The Federal Reserve is facing a delicate balancing act. Comerica’s Adams cautioned that if tariffs increase on April 2 as planned, inflation could pick up further in the coming months.
"The Fed is in a tricky spot. On one hand, the economy is downshifting, which argues for lower rates. On the other hand, inflation looks set to pick up," he said.
Adams predicts the Fed will cut rates by 25 basis points around midyear, likely in July, with the economy regaining momentum by fall. However, he warned that risks are skewed toward the Fed cutting faster than the base case if economic weakness persists.
Roach also pointed to potential risks, stating that while stable real disposable income growth "will likely provide a buffer for an economy nervous about a trade war and sticky inflation," any faltering in income growth could put the economy at greater risk.