By Lucia Mutikani
WASHINGTON (Reuters) - U.S. consumer spending increased by the most in six months in July as Americans bought more goods and services, but slowing monthly inflation rates cemented expectations that the Federal Reserve would keep interest rates unchanged next month.
The report from the Commerce Department on Thursday, together with other data showing an unexpected decline in first-time applications for unemployment benefits last week, further diminished the risks of a recession this year.
The current pace of increase in consumer spending is, however, unlikely sustainable. Households are drawing down excess savings accumulated during the COVID-19 pandemic. Student debt repayments resume in October for millions of Americans and higher borrowing costs could make it harder for consumers to keep using credit cards to fund purchases.
"Americans keep spending," said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto. "The 'soft landing' view still holds, but there are some warning signs coming from the consumer as the savings rate continues to tick down."
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased 0.8% last month. Data for June was revised slightly higher to show spending rising 0.6% instead of 0.5% as previously reported. Economists had forecast spending increasing 0.7%.
Spending on goods increased 0.7% last month mostly reflecting products with a short life span, including pharmaceuticals, recreational items, groceries and clothing. There were also increases in outlays on recreational goods and vehicles as well as household furnishings and equipment and other long-lasting goods.
Services spending increased 0.8%, driven by portfolio management and investment advice services, housing and utilities, restaurants and healthcare. Despite the hype about movie releases, including Barbie and Oppenheimer, as well as concerts by artists like Taylor Swift, boosting spending over the summer, spending on recreation services rose marginally.
"This could suggest upside risks for services consumption in August," said Veronica Clark, an economist at Citigroup (NYSE:C) in New York.
When adjusted for inflation, consumer spending increased 0.6%, also the largest gain since January. The so-called real consumer spending rose 0.4% in June. Last month's solid increase put real consumer spending on a higher growth path at the start of the third quarter, prompting economists to raise their gross domestic product estimates.
JPMorgan boosted its GDP estimate for the July-September quarter to a 3.5% annualized rate from a 2.5% pace. The economy grew at a 2.1% rate in the second quarter.
With the saving rate dropping to 3.5% last month, the lowest since November 2022, the outlook for consumer spending is less robust. The saving rate was at 4.3% in June. Some of the drop in July was attributed to higher taxes, which left income at the disposal of households after accounting for inflation declining 0.2% last month.
Stocks on Wall Street were trading higher. The dollar rose against a basket of currencies. U.S. Treasury yields fell.
TIGHT LABOR MARKET
Inflation as measured by the personal consumption expenditures (PCE) price index rose 0.2% last month, matching June's gain. Food prices climbed 0.2% and energy edged up 0.1%. In the 12 months through July, the PCE price index increased 3.3% after advancing 3.0% in June.
Excluding the volatile food and energy components, the PCE price index gained 0.2%, after climbing by the same margin in the prior month. The so-called core PCE price index increased 4.2% year-on-year in July after rising 4.1% in June.
The annual PCE inflation rates were lifted by a lower base of comparison last year. The Fed tracks the PCE price indexes for its 2% inflation target.
"But make no mistake, the monthly sequential momentum around 0.2% is exactly what Fed policymakers are looking for to get inflation back toward the 2% target," said Gregory Daco, chief economist at EY-Parthenon in New York.
Since March 2022, the Fed has raised its policy rate by 525 basis points to the current 5.25%-5.50% range. Financial markets expect the U.S. central bank will leave its benchmark overnight interest rate unchanged at its Sept. 19-20 policy meeting, according to the CME Group's (NASDAQ:CME) FedWatch Tool.
Economists estimated that costs for core services excluding housing, closely watched by policymakers, increased 0.5% after gaining 0.3% in June. That led some to believe the Fed could raise interest rates in November.
"The Fed has to see substantial disinflation in core services before it can consider letting its guard down on inflation," said Conrad DeQuadros, senior economic advisor at Brean Capital in New York.
Though the labor market is cooling, with job openings dropping to their lowest level in nearly 2-1/2 years in July, conditions remain tight. Employers are mostly hanging on to workers after difficulties hiring during the COVID-19 pandemic.
Initial claims for state unemployment benefits fell 4,000 to a seasonally adjusted 228,000 for the week ended Aug. 26, the Labor Department said in a separate report on Thursday. Economists had forecast 235,000 claims for the latest week.
The number of people receiving benefits after an initial week of aid, a proxy for hiring, rose 28,000 to 1.725 million during the week ending Aug. 19.
The claims data have no bearing on August's employment report, which is scheduled for release on Friday.
According to a Reuters survey of economists, nonfarm payrolls likely increased by 170,000 jobs in August after rising by 187,000 in July. The unemployment rate is forecast unchanged at 3.5%, a more than 50-year low.
"While signs of looser labor markets are emerging, the jobless claims data are a reminder that the cooling in labor market conditions is being accompanied by very few layoffs," said Nancy Vanden Houten, lead U.S. economist at Oxford Economics in New York.