Will Inflation Reach the Fed’s 2% Target?

The latest Personal Consumption Expenditures (PCE) report, a crucial gauge for inflation, showed headline prices rose just 0.1% in May, bringing the annual rate to 2.3%. These figures were mostly in line with forecasts.

However, the focus is often on Core PCE. This measure strips out volatile food and energy costs and is the Federal Reserve’s preferred inflation metric. Core PCE increased 0.2% in May, coming in slightly above the 0.1% forecast. On an annual basis, Core PCE now stands at 2.7%.

Reaching the Fed's 2% Core PCE goal may be challenging in the near term, potentially until early 2026. This is because inflation is calculated on a rolling 12-month basis, which means that the total of the past 12 monthly inflation readings will give us the year-over-year rate of inflation.

Moving forward, the relatively low monthly figures from June to December 2024 (0.1% to 0.29%) will drop out of the annual calculation, making it harder for new monthly data to bring the rate down significantly.

However, the outlook improves for 2026. Higher monthly figures from early 2025 (0.34% in January and 0.48% in February) will drop out next year. Replacing these with potentially lower monthly increases should help accelerate progress toward the 2% target.

So, what does this mean for Fed rate cuts?

The Federal Reserve is tasked with two main goals: keeping prices stable and achieving maximum employment. Balancing these objectives can be tricky, especially with new tariffs adding to economic uncertainty. Typically, when inflation persists, the Fed is less likely to cut rates. Conversely, signs of an economic slowdown might lead them to consider lowering rates.

At their meeting on June 18, the Fed's policymakers unanimously decided to keep their key interest rate, the Federal Funds Rate, unchanged at 4.25% to 4.5%. This continues the pause in rate changes that began in January and was largely expected by financial analysts. The decision highlights the Fed's ongoing effort to manage the risks of both rising prices and increasing unemployment.

Looking ahead, the Fed will pay close attention to upcoming reports on inflation and jobs. Their future policy decisions will likely depend on whether inflation or employment concerns become more pressing. Notably, the Fed's latest forecasts for 2025 now project core PCE inflation to be higher at 3.1%, up from their previous estimate of 2.8%.

They also project the unemployment rate will tick up slightly to 4.5%, compared to the 4.4% estimate from March. The current unemployment rate was 4.2% in May, with the data for June expected later this week.

Despite these uncertainties and revised projections, the Fed's most recent economic forecasts show that most officials still expect to cut the Fed Funds Rate twice later this year.

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