PCE inflation steady but elevated
With labor market vulnerability rising and consumer spending slowing, the Fed may cut rates soon despite inflation staying above target. Policy now looks ahead to mid-2026.
Weekly highlights
Steady.
Highest since February
Exports weighed on GDP
Stronger consumption
Stronger than expected
Second consecutive quarterly decline
-1.6%
6-month high, but perplexing
Driven by electricity prices, may reverse.
US: The wait may be over soon
The long wait for the resumption of Fed rate cuts may be soon over. Almost irrespective of the next payrolls report, there is enough softness in broader labor market data to warrant a modest reduction in the Fed Funds rate.
Whatever objections there are to such a move center on the reality that inflation is not yet at target, nor is it likely to get there very soon. That is undeniable, as Figure 1 below illustrates. The latest PCE (personal consumption expenditure) inflation data were, at the margin, more constructive than we anticipated, but with headline at 2.6% and core at 2.9%, we are a way away from the ideal end point. We will probably get even further away from it before the year is over.
Why, then, do we support a rate cut in September (we’ve argued in favor of a July cut as well) and a total of three in 2025?
In short, because at the September meeting, the Fed is truly making policy for the middle of 2026, and we put more weight on growing labor market vulnerability. On one hand, it is impressive how well the economy has performed despite the many policy shocks of the last few months. But it is also clear that consumer spending is slowing. It grew 0.3% QoQ on average during the first half of 2025, half the pace of a year earlier.
Keeping it growing rests on ensuring that the labor market does not transition from the current phase of slow hiring to outright firing. And we believe that calibrating interest rates lower is critical to prevent that shift from happening and/or taking hold.
Canada: Stronger domestic demand
Headline GDP contracted at an annualized rate of 1.6% in Q2, representing a marked slowdown from the 2% increase observed in Q1. This outcome aligns closely with the Bank of Canada’s July projection of -1.5% under its “current tariff scenario,” though there are nuanced differences among the underlying components.
The principal weakness remains concentrated in sectors sensitive to international trade, as the Q2 GDP decline is mainly attributable to a sharp reduction in exports following the pre-tariff inventory buildup that bolstered growth in Q1. Excluding net trade and inventory effects, final domestic demand demonstrated a rebound after a subdued first quarter.
Although business investment declined, this decrease was counterbalanced by increases in household consumption and a recovery in residential investment.
Looking ahead, ongoing trade disruptions are expected to continue exerting downward pressure on investment activity, while the prospects for further gains in household spending appear increasingly limited due to a weakening labor market. We will continue to closely monitor these trends for any signs that softness within trade-exposed sectors is expanding.
Today's GDP data aligns with the Bank of Canada's forecast, accompanied by stronger domestic demand. Meanwhile, the Q2 GDP contraction suggests more economic slack, and despite a possible stronger Q3, excess supply is expected to persist, likely keeping inflation low and possibly leading to further rate cuts this year.
Australia: Q2 GDP in focus
Inflation data for July came in significantly above expectations, with headline inflation at 2.8% YoY and core inflation at 2.7%. While both figures remain within the Reserve Bank of Australia’s (RBA) target band, the headline print is 90 basis points higher than the previous month.
The upside surprise was largely driven by a sharp 13.0% MoM increase in electricity prices, which carry a 2.5% weight in the CPI basket. This spike was an unintended consequence of regulated price increases coinciding with timing-related issues in the disbursement of energy subsidies. The Australian Bureau of Statistics noted that Q3 Commonwealth energy rebates for households in New South Wales and the Australian Capital Territory (ACT) were deferred to August, resulting in higher household expenses in July.
Additional contributors to the inflation print included a 4.7% MoM rise in travel and accommodation prices. Food prices edged up by 0.1%, new dwelling purchase costs and rents by 0.4% and 0.3% respectively.
The RBA is expected to take note of these developments, especially in light of its August meeting minutes, which reflected a balanced discussion on the case for further rate cuts. With the Board emphasizing a data-dependent approach, attention now turns to the Q2 GDP release scheduled for next week.
Consensus expectations point to a 0.5% QoQ increase, although our tracking model suggests a modest upside risk (0.64%). This view is supported by partial indicators released this week, including a 0.2% rise in private capital expenditure following a downwardly revised -0.2% in Q1, and a 3.0% increase in construction work done, driven by a 13.5% surge in engineering activity and a 17.5% jump in the ACT.
Should the GDP data surprise to the upside, it could prompt the RBA to adopt a more measured approach to easing, potentially slowing the pace of rate cuts.
Catch the whole story...
There's more to the Weekly Economic Perspectives in PDF. Take a look at our Week in Review table – a short and sweet summary of the major data releases and the key developments to look out for next week.