Did U.S. Inflation Cool More Than Expected?

The Federal Reserve’s preferred inflation gauge delivered a softer-than-expected reading for August, potentially reducing some of the pressure for another interest-rate increase at the central bank’s October meeting. The Personal Consumption Expenditures price index rose 3.4% from a year earlier, below expectations for a 3.7% increase.

The underlying inflation picture was also softer. Core PCE, which excludes volatile food and energy prices, increased 3% annually, down from 3.3% in July and below the 3.3% increase expected. On a monthly basis, core PCE rose 0.2%, easing from 0.3% in July and also below expectations.

The figures provide additional evidence that price pressures have moderated, although inflation remains above the Federal Reserve’s 2% objective.

How Much Did the PCE Methodology Change the Picture?

Part of the improvement reflected revisions by the Bureau of Economic Analysis to the way it calculates inflation for computer software, legal fees and investment advice. The changes were applied retroactively to 2021.

Two of the affected categories, computer software and investment advice, experienced significant price increases over the past year. Capital Economics estimated that the revisions reduced annual core inflation by approximately 0.3 percentage point.

Downward revisions to June and July price growth also changed the recent inflation trajectory. According to Capital Economics, the three-month annualized core inflation rate is now running at precisely 2%.

Could the Data Shift the Fed’s October Decision?

The softer inflation report arrives after New York Fed President John Williams argued that there was no need for urgency regarding another rate increase. Speaking Tuesday, Williams said policymakers had time to gather additional information before determining the appropriate monetary-policy setting.

Williams nevertheless indicated that he expects another rate increase later in the year to support a more timely return of inflation toward the Federal Reserve’s 2% goal. The timing of that potential move remains uncertain, with the comments potentially pointing toward December rather than the October meeting.

How Have Rate-Hike Expectations Changed?

Financial markets sharply reduced expectations for an October increase following Williams’ comments and the latest inflation data. CME futures indicated roughly a 35% probability of an October rate hike, compared with approximately 50% on Tuesday and around 70% earlier in the week.

The change illustrates how sensitive interest-rate expectations remain to incoming inflation and policy signals. A cooler PCE reading can reduce the immediate case for additional tightening, while future inflation and economic data will determine whether policymakers continue to see persistent price pressures as a concern.

What Could Come Next for Monetary Policy?

The August PCE report gives policymakers another data point suggesting that underlying inflation pressures may be less persistent than previously feared. The methodological revisions also complicate comparisons with earlier readings, making the broader trend particularly important for investors watching monetary policy.

For markets, the next phase will depend on whether inflation continues moving toward the Fed’s target while economic activity remains resilient. The distinction between an October pause and a later rate increase could remain important for Treasury yields, the dollar and risk assets as policymakers gather additional evidence.