Core PCE hits 3.4%, highest since 2023, as Fed rate hike risks rise

The Federal Reserve's preferred inflation gauge accelerated to its highest core reading in more than two years, keeping rate hikes on the table for 2026.

Core PCE inflation rose to 3.4% in May, the highest since October 2023, reinforcing the Fed's hawkish stance and keeping at least one rate hike on the table for this year.

"Broad-based inflation pressures mean the Fed cannot afford to wait," said Matthew Luzzetti, chief US economist at Deutsche Bank. "We expect two 25-basis-point rate hikes this year, in September and December."

The Commerce Department report showed personal spending rose 0.7% in May, exceeding the 0.4% forecast, while personal income also climbed 0.7% against a 0.4% estimate. The personal saving rate edged up to 3%. Month-over-month, headline PCE rose 0.4%, a tenth of a percentage point below expectations, while core prices accelerated to 0.3% from 0.2% in April.

The data complicates the Fed's path just as a new variable enters the equation: oil prices have plunged following President Donald Trump's deal with Iran, potentially easing headline inflation in coming months. Still, with core inflation running well above the Fed's 2% target and consumer spending showing no signs of cracking, markets now price a 50% probability of a quarter-point rate hike by the September meeting, according to OIS pricing.

Consumer Spending Defies Slowdown Expectations

The 0.7% monthly gain in personal consumption expenditures — a proxy for spending — marked the strongest reading in months and came despite elevated price pressures. Real consumer spending, adjusted for inflation, also rose, suggesting households are drawing down savings to maintain consumption levels. The saving rate at 3% remains below the pre-pandemic average of about 7%, a dynamic that economists say is unsustainable over the long term but could keep the economy running hot through the third quarter.

The resilience in spending gives the Fed cover to maintain its tightening bias. Nine of 12 Fed officials penciled in at least one rate hike this year in their latest projections, with six seeing two or more increases. Only eight favored holding rates steady through year-end, according to the Summary of Economic Projections released after the June meeting.

Oil Plunge Offers a Wildcard for Inflation Outlook

The inflation picture may shift in the months ahead as lower energy costs feed through the data. President Trump's deal with Iran, which secured continued access through the Strait of Hormuz, sent oil prices sharply lower, easing a key driver of this year's inflation surge. Headline PCE had been pushed higher by energy costs tied to the Iran conflict, which the Commerce Department said had been seeping into other parts of the economy.

Fed officials project headline PCE will end the year at 3.6% and core at 3.3% — both well above the 2% target. If oil remains subdued, headline inflation could moderate faster than anticipated, potentially reducing the pressure for rate hikes. However, Deutsche Bank's Luzzetti cautioned that core inflation, which strips out energy and food, is being driven by broader demand-side pressures that lower oil prices alone will not resolve.

The last time core PCE exceeded 3.4% was in October 2023, when it peaked at 3.5% before beginning a gradual descent. That decline stalled in early 2025, and inflation has been grinding higher since, driven by tariffs, a tight labor market, and the energy shock from the Iran conflict. The Fed's next policy decision is scheduled for July 29-30, followed by the September 16-17 meeting, where markets see the highest probability of a move.

This article is for informational purposes only and does not constitute investment advice.