PCE Inflation Heats Up

What It Means for the Fed and Your Wallet

​In January 2025, the Personal Consumption Expenditures (PCE) price index—a key inflation measure favored by the Federal Reserve—rose by 0.3% from December, translating to a 4.0% annualized increase. This marks the most significant month-to-month rise since March 2024. Consequently, the three-month PCE inflation rate accelerated to a 2.9% annualized increase, the highest since April 2024.

Understanding the PCE Price Index

The PCE price index reflects changes in the prices of goods and services purchased by consumers in the United States. Unlike the Consumer Price Index (CPI), which measures out-of-pocket expenditures, the PCE captures a broader range of expenditures, including those not directly paid for by consumers, such as healthcare services covered by employer-provided insurance. This comprehensive approach makes the PCE a preferred measure for the Federal Reserve when assessing inflation and setting monetary policy.​

Breakdown of January's Inflation Data

• Goods Prices: In January, goods prices experienced a notable increase, marking the first positive shift in a year. This surge was the most significant since August 2023, indicating potential changes in consumer demand or supply chain dynamics.

• Core PCE Price Index: Excluding volatile food and energy prices, the core PCE price index rose by 0.3% month-over-month, or 3.5% annualized. This uptick is the sharpest since October 2024, underscoring persistent inflationary pressures in the broader economy.

• Services Sector: The core services PCE price index, which excludes energy services, showed mixed results. While some subindices, such as healthcare services and transportation services, experienced declines, others like housing and recreation services saw significant increases. This variability highlights the complex nature of inflation within the services sector.

The Role of Base Effects in Year-over-Year Inflation

Year-over-year inflation comparisons can be influenced by the base effect, which occurs when the inflation rate is affected by unusually high or low levels in the corresponding period of the previous year. In January 2024, the services PCE price index had spiked by 0.68% month-over-month (an annualized 8.5%). As this high reading dropped out of the 12-month calculation in January 2025, it was replaced by the more moderate 0.24% increase from January 2025. This substitution led to a deceleration in the year-over-year change to 3.4%, illustrating how base effects can mask underlying inflation trends.

Implications for Monetary Policy

The Federal Reserve closely monitors the PCE price index to gauge inflationary trends and inform monetary policy decisions. The recent acceleration in month-to-month and three-month annualized PCE inflation rates suggests that inflationary pressures remain robust. However, the deceleration in year-over-year measures, influenced by base effects, presents a nuanced picture. This complexity may lead the Fed to adopt a cautious approach, balancing the need to contain inflation without stifling economic growth.​

Consumer Spending and Economic Outlook

In January, U.S. consumer spending unexpectedly declined by 0.2%, contrasting with December's 0.8% increase. Economists had anticipated a modest 0.1% rise, making this downturn noteworthy. Factors such as fading tariff-driven purchases, cold weather, and natural disasters contributed to the weakening spending. Despite the spending drop, inflation picked up, with the PCE price index rising 0.3% in January, similar to December. Core PCE inflation, excluding food and energy, also increased by 0.3%. Concerns over tariffs and their potential to elevate costs and disrupt supply chains have diminished business and consumer confidence. The U.S. economy is anticipated to grow more slowly in the first quarter, with GDP estimates below a 2.0% annualized rate.

Global Context and External Factors

Inflation trends in the U.S. are not isolated; global economic conditions play a significant role. For instance, the eurozone experienced an uptick in inflation to 2.3% in November 2024, influenced by a statistical base effect, with last year's low figures being replaced by modestly higher ones. Despite this increase, underlying inflation remained stable, suggesting that base effects can have varying impacts across different economies. ​

The latest PCE inflation data should serve as a wake-up call for anyone still believing the Federal Reserve has inflation under control.

While year-over-year numbers may appear tamer due to statistical base effects, the reality is that month-to-month inflation is running hot, with a 4% annualized rate—far above the Fed’s 2% target.

Core inflation, particularly in services, remains stubbornly high, signaling that inflationary pressures are deeply embedded in the economy.

Despite aggressive rate hikes over the past two years, inflation is proving far more resilient than policymakers had hoped. The recent resurgence in price increases suggests that the Fed’s tightening cycle may not have been enough—or worse, that inflation is regaining strength just as financial markets and businesses are expecting rate cuts.

If the Fed miscalculates and eases policy too soon, inflation could accelerate even further, forcing an even more painful response later. With economic growth slowing and consumer spending faltering, the central bank is now caught between a rock and a hard place: fight inflation more aggressively or risk losing credibility altogether. Either way, the battle is far from over, and the consequences of getting it wrong could be severe.