U.S. Consumer Spending Posts Biggest Gain In Nearly Two Years; Inflation Picks Up

U.S. consumer spending increased by the most in nearly two years in January amid a surge in wage gains, while inflation accelerated, adding to financial market fears that the Federal Reserve could continue raising interest rates into summer.

The report from the Commerce Department on Friday was the latest indication that the economy was nowhere near a much-dreaded recession. It joined data earlier this month showing robust job growth in January and the lowest unemployment rate in more than 53 years.

"Clearly, tighter monetary policy has yet to fully impact consumers and shows that the Fed has more work to do in slowing down aggregate demand," said Jeffrey Roach, chief economist at LPL Financial in Charlotte, North Carolina. "This report all but insures the Fed will continue on its rate hiking campaign for a lot longer than markets anticipated just a few weeks ago."

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, shot up 1.8% last month. That was the largest increase since March 2021. Data for December was revised higher to show spending dipping 0.1% instead of falling 0.2% as previously reported. Economists polled by Reuters had forecast consumer spending rebounding 1.3%.

Graphic: Personal consumption

When adjusted for inflation, consumer spending increased 1.1%, also the biggest gain since March 2021. The so-called real consumer spending had declined in November and December.

Consumers boosted purchases of long-lasting manufactured goods like motor vehicles, household furnishings and equipment as well as recreational goods and vehicles. They also bought clothes. Goods outlays rebounded 2.8%. Spending on services was also strong, rising 1.3% as Americans frequented restaurants and bars. There were increases in spending on healthcare, recreation and transportation services.

The overall surge in spending came as wages and salaries jumped 0.9%. An 8.7% cost of living adjustment, the biggest increase since 1981, for more than 65 million Social Security beneficiaries offset a drop in government social benefits. That reflected the expiration of the extended child tax credit.

Spending was also likely flattered by difficulties ironing out seasonal fluctuations from the data at the start of the year. Some economists expect payback in February.

Nevertheless, the strong performance put consumer spending on a higher growth path at the start of the first quarter. Consumer spending slowed in the fourth quarter, with most of the loss in momentum happening in the last two months of 2022.

The data together with another Commerce Department report showing new home sales vaulting 7.2% in January prompted Goldman Sachs to raise its first-quarter gross domestic product tracking estimate by 0.4 percentage point to a 1.8% annualized rate. The economy grew at a 2.7% pace in the fourth quarter.

Stocks on Wall Street fell. The dollar firmed against a basket of currencies. U.S. Treasury yields rose.

Graphic: New home sales

MORE RATE HIKES

Financial markets have been on edge since the release of January's blockbuster employment report.

The Fed is expected to deliver two additional rate hikes of 25 basis points in March and May. Traders on Friday raised their bets for another increase in June. The U.S. central bank has raised its policy rate by 450 basis points since last March from near zero to a 4.50%-4.75% range.

The personal consumption expenditures (PCE) price index shot up 0.6% last month, the largest increase since June 2022, after gaining 0.2% in December. In the 12 months through January, the PCE price index accelerated 5.4% after rising 5.3% in December.

Excluding the volatile food and energy components, the PCE price index increased 0.6%. That was the biggest gain since August 2022 and followed a 0.4% rise in December. The so-called core PCE price index increased 4.7% on a year-on-year basis in January after advancing 4.6% in December.

The Fed tracks the PCE price indexes for monetary policy. According economists' calculations, core services prices excluding housing, which are being closely watched by policymakers, increased 0.6% after climbing 0.4% in December.

The rise in inflation reflects upgrades to consumer and producer prices in annual revisions published this month. Businesses also push through price increases at the beginning of the year. The latest high readings left economists to expect that the road to disinflation would be slow and bumpy, with a survey from the University of Michigan on Friday showing consumers' near-term inflation expectations increased in February.

Graphic: UMich inflation expectations

But some believe the year-on-year PCE price data will be revised lower when the Commerce Department's Bureau of Economic Analysis (BEA) publishes its annual revisions to the series later this year. The year-on-year CPI and PPI data were not impacted by the annual revision.

"But so far the PCE price data are only getting the upward revision from the annual revisions to the underlying source data from recent months without getting the offsetting downward revisions to earlier months," said Daniel Silver, an economist at JPMorgan in New York. "This means that year-ago rates for the PCE price data in recent months are 'too high' right now and likely will be revised down in the BEA's own annual revision coming in the fall."

Personal income increased a solid 0.6%, the bulk of it coming from strong wage growth. Income at the disposal of households after adjusting for inflation surged 1.4%, the largest increase since March 2021. Disposable income was also boosted by a 7.9% drop in tax payments.

Consumers increased savings even as they stepped up spending. The saving rate rose to 4.7%, the highest in a year, from 4.5% in December.

"Households are drawing down excess savings at a slower rate than before, likely due to recession concerns," said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto.