Core PCE Held at 3.3% in July as Fed's Inflation Challenge Persists

The Commerce Department reported that core PCE rose 0.2% in July and 3.3% year over year, leaving the Fed's preferred inflation gauge well above its 2% target heading into September.

July PCE in line with expectations

The personal consumption expenditures price index, the Federal Reserve's preferred inflation gauge, increased a seasonally adjusted 0.2% in July, putting the headline annual rate at 3.7%, the Commerce Department reported on August 26. Both headline figures were 0.1 percentage point above the consensus forecast. Stripping out volatile food and energy costs, core PCE posted respective gains of 0.2% for the month and 3.3% year over year—in line with economist expectations.

While the Fed considers both headline and core measures, policymakers generally regard core inflation as the better indicator of longer-term trends because it excludes categories that can swing sharply from month to month. At 3.3%, core PCE has remained persistently above the 2% target since 2021, giving the FOMC little room to declare victory on price stability.

Why the Fed watches PCE rather than CPI

The PCE index differs from the better-known Consumer Price Index in several ways that matter for policy. PCE accounts for consumer substitution—when the price of one good rises, consumers switch to alternatives, and the index reflects that behaviour. PCE also uses a broader weighting methodology and includes expenditures paid on behalf of consumers, such as employer-provided healthcare. For these reasons, the Fed has used PCE as its primary forecasting tool since 2000.

MRA Advisory Group noted in its September outlook that the July figures remain well above the Fed's 2% objective and that the trajectory of energy prices is particularly important following renewed conflict around the Strait of Hormuz. An oil shock on top of sticky core inflation creates a policy dilemma: the energy component pushes headline PCE higher even if core trends are gradually moderating.

Market reaction and rate expectations

The July PCE report landed during a week when Fed Chair Kevin Warsh was already shifting market expectations at Jackson Hole. Warsh said inflation was running above the 2% target and that the Fed's predominant focus should be on prices. Fed funds futures moved from pricing roughly one-third odds of a September hike before the speech to better than even odds afterward.

Some analysts argued the data did not fully support the hawkish repricing. Three-month annualised PCE inflation had been declining since March, and six-month PCE fell for two consecutive months after peaking in May. The tension between a cooling short-term trend and a headline figure still well above target is precisely what makes the September FOMC decision difficult to predict.

What August data may reveal

The August CPI report, due September 10, will be the next major inflation release before the FOMC meeting. If core CPI accelerates above 3.5% year over year, the case for a September hike strengthens even against mixed employment data. Conversely, a softer reading could allow the committee to hold while maintaining hawkish forward guidance.

For businesses, the persistence of core PCE at 3.3% means input cost pressures remain embedded in the economy even before accounting for the September oil shock. Wage growth, services inflation, and shelter costs continue to be the primary components keeping core elevated, and those categories tend to adjust more slowly than energy prices—making any relief from lower oil contingent on broader disinflationary trends that have yet to fully materialise.