Prices resumed rising in July, and this time energy had nothing to do with it.
The Personal Consumption Expenditures Price Index (PCEPI), the Federal Reserve’s preferred measure of inflation, rose 0.2 percent in July, according to new data from the Bureau of Economic Analysis (BEA), reversing the 0.1 percent decline recorded in June. The index has risen at an annualized rate of 4.1 percent over the last six months and is 3.7 percent higher than a year ago — unchanged from June.
Core PCEPI, which excludes volatile food and energy prices, increased 0.2 percent in July. It has risen at an annualized rate of 3.5 percent over the last six months and is 3.3 percent higher than a year ago, also unchanged from June.
June’s decline was an energy story. Energy prices surged this spring after conflict in the Middle East disrupted oil shipments, then fell sharply as supplies recovered, briefly pulling the headline index negative. In July, energy prices fell again, yet the headline index rose anyway. Services prices increased 0.3 percent. When energy stops boosting the headline number, what remains is the underlying trend.
Swings in energy prices can make headline inflation volatile, especially from month to month, because energy is included directly in the index. These swings primarily change the price of energy relative to other goods and services; they do not necessarily signal a broad change in the rate at which prices are rising. Moreover, they often reflect supply conditions outside monetary policy’s control. An energy-driven rise or fall in headline inflation therefore does not, by itself, tell us whether monetary policy is on the right track. The more relevant question is whether total spending is growing at a rate consistent with price stability.
July’s own numbers hint at the answer. Consumers spent 0.2 percent more last month but bought no more than in June: adjusted for inflation, spending was flat. The quarterly data say the same. Nominal spending, the dollar value of all final goods and services produced in the economy, grew at an annualized rate of 8.0 percent in the second quarter, according to the revised estimate the Bureau released with the inflation data. From the second quarter of 2025 through the second quarter of 2026, nominal spending rose by 6.6 percent. By comparison, nominal spending grew at an average annual rate of roughly 4.1 percent from 2015 through 2019.
Nominal spending cannot consistently outpace the economy’s productive capacity without ultimately leading to higher inflation. If real output grows around 2.5 percent per year, then nominal spending cannot rise by more than roughly 4.5 percent if the Fed hopes to hit its 2 percent inflation target. Growth of 6.6 percent leaves a gap of about two percentage points, meaning that monetary policy is currently too loose.
There has been progress. Over the last six months, headline inflation has fallen from 5.4 percent in May to 4.1 percent today, and the core measure has eased as well. Since monthly figures fluctuate, and monetary policy affects the economy with a lag, the Fed should not react mechanically to a single report. Nonetheless, inflation is currently double the Fed’s target, and with nominal spending growing at nearly 7 percent, it won’t come back down without tighter monetary policy.
At its July meeting, the committee held its target range for the federal funds rate at 3.5 to 3.75 percent, with three members dissenting in favor of a quarter-point increase. The minutes, released last week, reveal how contingent that hold was: “Many participants assessed that policy tightening would likely be necessary if inflation did not decline.” Participants also judged that inflation risks “were skewed to the upside,” meaning inflation was more likely to exceed their forecast than to fall below it. Yesterday’s report from the BEA suggests that the Fed should raise its policy rate at its meeting next month, although the CME Group’s FedWatch tool indicates that market participants still expect the Fed to hold steady.
One month of rising prices no more dooms the inflation fight than one month of falling prices ended it. However, the pattern suggests that the work to bring inflation back to target is not done: headline inflation remains well above 2 percent, core inflation remains elevated, and nominal spending continues to grow too rapidly. The inflation fight will not be over until nominal spending settles onto a path consistent with the economy’s productive capacity.
September’s meeting will show whether the committee believes its own minutes.
