A slower economy is usually unwelcome, but the Federal Reserve might need it to combat high inflation.
The latest consumer spending and inflation report should reassure Fed officials. Spending hit a three-month low in April, and inflation showed signs of leveling off.
“This was a Fed-friendly personal income and spending report showing consumers are becoming more cautious in the second quarter,” said Scott Anderson, chief U.S. economist at BMO Capital Markets.
“Additionally, decreasing demand seems to be easing the earlier inflation surge.”
The Fed might get more positive news from the May employment report if it shows a modest job increase. Labor shortages have driven up wages, complicating inflation control.
Wall Street predicts 178,000 new jobs in May, similar to April’s 175,000, the smallest rise in two years.
Still, inflation remains high.
The PCE price index, the Fed’s preferred measure, is close to 3%, with other indicators like the consumer price index even higher.
Yet, the April report hinted that the early 2024 inflation surge might be over.
“The good news is things didn’t worsen,” said Eugenio Aleman, chief economist at Raymond James.
For inflation to decrease, economic growth must slow further.
When consumers cut spending, businesses hire less or reduce prices, both of which lower inflation.
The risk is a weaker economy could lead to a recession.
A downturn would curb inflation but cause significant job losses.
Fed officials want to avoid a recession and could lower interest rates to prevent it. However, they need more proof that inflation is declining before cutting rates.
Some Fed economists doubt the 2% inflation target will be met soon.
A Cleveland Federal Reserve paper suggests a 2% inflation rate might not be achievable until 2027, longer than Washington’s forecast.
Nonetheless, Fed officials have indicated they are ready to cut rates as soon as inflation starts to decrease, without waiting for it to reach 2%.
The Fed would likely act swiftly if the economy starts to falter.
