US inflation remains elevated as GDP growth outlook improves

The Bureau of Economic Analysis released its latest batch of economic data showing the Personal Consumption Expenditures price index, the Fed’s preferred inflation gauge, rose 3.7% year-over-year in July. That matched June’s reading and came in above the 3.6% economists had penciled in.

The numbers behind the stubbornness

Core PCE, which strips out volatile food and energy prices, held steady at 3.3% on an annual basis.

Inflation has now exceeded the Fed’s 2% target for 65 consecutive months.

The Consumer Price Index, a separate but related measure, offered a small consolation. CPI came in at 3.4% year-over-year in July, ticking down from 3.5% in June.

Energy costs continue to be a primary villain in this inflation story. Geopolitical tensions in the Middle East have kept energy prices elevated, and those costs ripple through virtually every sector of the economy.

Growth finds a second wind

The BEA maintained its estimate for second-quarter real GDP growth at an annualized rate of 1.5%. What caught attention was the upward revision to consumer spending growth, bumped from 3.2% to 3.4%.

Looking ahead, economists have grown more optimistic about the third quarter. Some forecasts now peg Q3 GDP growth at around 2.5% annualized. The drivers behind that confidence include robust consumer demand, continued private sector investment, and capital pouring into artificial intelligence infrastructure.

What the Fed faces now

Markets appear to believe the Fed will lean hawkish. Investors have priced in a 42% probability of a rate hike at the September meeting.

Analysts who reviewed the data characterized it as supportive of a tighter monetary policy stance. The logic is simple: if the economy can sustain 3.4% consumer spending growth while rates are already elevated, perhaps rates aren’t high enough to bring inflation back to target.

But there are complicating factors. New tariffs pose a risk to the growth outlook, potentially raising costs for businesses and consumers while simultaneously slowing trade activity. Geopolitical uncertainties beyond energy markets add another layer of unpredictability.

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