Inflation saps U.S. consumer confidence; house prices remain elevated

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US consumer spending fell in May for the first time this year and prior months were revised lower, suggesting an economy on somewhat weaker footing than previously thought amid rapid inflation and Federal Reserve interest-rate hikes.

The economy is on recession watch as the Federal Reserve aggressively tightens monetary policy to tackle inflation. For now, it continues to grow, with other data on Tuesday showing the goods trade deficit again narrowing significantly in May as exports hit a record high.

“Right now we are at an inflection point in the economy, where actual spending and economic activity is still positive, however, consumer confidence and financial conditions, especially interest rates, are indicating a slowdown ahead,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance in Charlotte, North Carolina.

Purchases of goods and services, adjusted for changes in prices, decreased 0.4% after a downwardly revised 0.3% gain a month earlier, Commerce Department data showed Thursday. Spending on services advanced while outlays for goods declined. 

The personal consumption expenditures price index, which the Federal Reserve uses for its inflation target, rose 0.6% from a month earlier and was up 6.3% since May 2021. The core PCE price index increased 0.3%, less than expected. It was up 4.7% from a year ago, the smallest gain since November.

The report offered new evidence that the U.S. economy hangs in a delicate balance as the Federal Reserve tries to bring inflation under control. Policymakers want to cool off consumer demand for goods and services, which has outstripped supply, driving up prices. But if the central bank chokes off demand aggressively when prices are already crimping consumption, it could cause a recession.

Consumers have hardly stopped spending. Overall demand remains strong, particularly for vacation travel, restaurant meals and other services that many families avoided earlier in the pandemic.

When accounting for inflation, consumer spending fell by 0.4% from April. That’s the first month-on-month decline in real consumption this year — and it’s unlikely to be the last, said Cailin Birch, global economist at the Economist Intelligence Unit.

Pullbacks in spending and, especially, consumers’ inflation expectations will continue to weigh heavily into the Fed’s future decision-making process on further rate hikes, she said.

The central bank abandoned its “easy money” policy earlier this year and launched a series of aggressive rate hikes in an attempt to tackle rising inflation and cool the economy.

 In March, the Fed raised rates for the first time since 2018, hiking its benchmark lending rate by 25 basis points, or 0.25%. That was followed by an increase of 50 basis points a few weeks later on May 4, and a 75-basis point hike earlier this month.

Consumer fears of a recession could become self-fulfilling. The University of Michigan’s survey last week showed consumer sentiment plunging to a record low in June.

The Conference Board survey places more emphasis on the labor market, which remains tight, but consumers are feeling the inflation pain. National gasoline prices averaged just above $5 per gallon for most of June, before slipping back to around $4.88 per gallon as of Tuesday, according to data from AAA. 

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