Fed's favored inflation gauge showed consumer price growth remained elevated in December

The Federal Reserve's preferred inflation gauge remained elevated in December as price pressures continued to pose a challenge for consumers.

The Commerce Department on Friday reported that the personal consumption expenditures (PCE) index rose 0.4% in December on a monthly basis and is up 2.9% from a year ago. Those figures were both slightly hotter than the estimate of LSEG economists, who predicted 0.3% and 2.8%, respectively.

Core PCE, which excludes volatile measurements of food and energy prices, was up 0.4% on a monthly basis and rose 3% year over year. Both figures were hotter than the expectations of economists polled by LSEG, who estimated the gauges would rise 0.3% and 2.9%, respectively.

Federal Reserve policymakers are focusing on the PCE headline figure as they try to bring inflation back to their long-run target of 2%, though they view core data as a better indicator of inflation.

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Headline PCE has trended up to 2.9% after readings of 2.8% in November and 2.7% in October. Core PCE readings were 2.8% or 2.9% dating back to May before it reached 3% in December.

Prices for goods were up 1.7% in December on an annual basis, up from 1.5% in November. Goods price growth was even lower last summer, when the index posted annual gains of 0.6% in June and July and a 0.9% gain in August.

Durable goods prices jumped 2.1% year over year in December after readings were close to 1% dating back to June. Nondurable goods rose 1.6% on an annual basis in December, slightly lower than the 1.7% reading in November.

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Services prices were up 3.4% from a year ago in December, a level that's been unchanged since September.

The personal savings rate as a percentage of disposable personal income was 3.6% in December, down from readings of 3.7% in October and November. That continues a steady decline from last May's 4.9% reading.

"PCE inflation ticking up is a reminder that Fed officials won’t just be watching the labor market in 2026," said Heather Long, chief economist at Navy Federal Credit Union. 

"Core PCE inflation rose to 3%, the highest since February 2025, and headline PCE inflation hit the highest since March 2024. This will trigger more concern inside the Fed that inflation needs a closer look again," Long added.

Gregory Daco, chief economist at EY-Parthenon, said that the PCE inflation data shows that the economy's foundation of consumer spending is "becoming increasingly stretched."

"Consumer activity is being propelled by affluent households while middle- and lower-income consumers are heavily relying on savings and borrowing to make ends meet. While the OBBBA and larger tax refunds may provide a temporary boost, muted job and wage gains will limit spending going forward," Daco said, adding that inflation is likely to remain near 3% in the first half of the year.

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Chris Zacarelli, chief investment officer at Northlight Asset Management, said that his firm thinks that the "Fed will continue to support the labor market with 3 or more rate cuts this year and will be patient as the inflation numbers come down (albeit at a slow pace) and although the AI debate will rage on, the stock market should eventually hit all-time highs again as the economy remains resilient and the central bank continues to be accommodative."

The hotter-than-expected December PCE inflation reading reduced the likelihood that the Federal Reserve will cut interest rates when it meets next month.

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The CME FedWatch tool shows a 96% probability that the Fed will leave rates unchanged, up from 90.8% a week ago and 78% a month ago.