US consumer spending falls; tariff-related boost to inflation awaited

Stocks on Wall Street gained, with the benchmark S&P 500 and the tech-heavy Nasdaq Composite indexes touching intraday record highs as investors bet on deeper Fed rate cuts. The dollar hit a fresh three-and-a-half-year low against the euro. Yields on shorter-duration U.S. Treasury notes rose.

Consumer spending nearly braked last quarter after being propelled by households pulling forward goods purchases. Households also spent less on services last quarter, helping to restrain growth in consumer spending to only a 0.5% annualized pace, the slowest rate since the second quarter of 2020.

A record goods trade deficit in the first quarter, thanks to a deluge of imports, accounted for much of the 0.5% rate of decline in gross domestic product during that period.

The trade gap has since contracted significantly, setting up growth for a sharp rebound this quarter. But the anticipated boost to GDP is likely to be blunted by the soft consumer spending, which fell 0.3% when adjusted for inflation last month after nudging up 0.1% in April.

SOLID WAGE GAINS

The Atlanta Fed cut its GDP growth estimate for the second quarter to a rate of 2.9% from the previously projected 3.4% pace. The expected rebound in growth this quarter will not be a sign of economic strength given the wild swings in trade.

Economists warned it could take time for the tariff-related distortions to wash out of the economic data. Despite the weakness, an imminent collapse in spending is unlikely as wages increased by a solid 0.4% last month.

But personal income dropped 0.4%, the largest decrease since September 2021, as the lift from retroactive Social Security payments to some retirees who draw public pensions – such as former police officers and firefighters – waned. The saving rate fell to 4.5% from 4.9% in April.

“The saving rate is still close in line with its average over the past few years, underlining that consumers are not pulling back sharply on their spending,” said Michael Pearce, deputy chief U.S. economist at Oxford Economics.

The Personal Consumption Expenditures (PCE) Price Index gained 0.1% in May, matching the rise in April, the BEA said. It was curbed by a sharp decline in gasoline prices, which partially offset higher costs for furnishings and durable household equipment. Overall goods prices climbed 0.1%.

The cost of services rose 0.2%, driven by housing and utilities, food services and accommodations. But the costs of financial services and insurance decreased.

In the 12 months through May, PCE inflation increased 2.3% after climbing 2.2% in April.

Most economists argue price increases have remained moderate because businesses are still selling inventory accumulated before the tariffs went into effect. They expect inflation will start picking up, beginning with consumer price data for June.

Some of them believe softening demand could make it harder for businesses to pass on tariffs to consumers.

Stripping out the volatile food and energy components, the PCE Price Index increased 0.2% last month. That followed a 0.1% rise in the so-called core PCE inflation in April.

In the 12 months through May, core inflation advanced 2.7% after rising 2.6% in April.

The Fed tracks the PCE price measures for its 2% inflation target. The central bank last week left its benchmark overnight interest rate in the 4.25%-4.50% range, where it has been since December. Economists expect rate cuts to resume in September.

“While some goods prices will probably increase, there is little danger of a more broad-based increase in inflationary pressure as services spending is slowing,” said Andrew Hollenhorst, chief U.S. economist at Citigroup. “Weaker consumer demand can also translate to softer hiring, raising downside risks to the Fed’s employment mandate.”

(Reporting by Lucia Mutikani; Editing by Paul Simao)