US Core PCE inflation softens to 3.9% as forecast

Inflation in the US, as measured by the change in Personal Consumption Expenditures (PCE) Price Index, rose to 3.5% on a yearly basis in August from 3.4% (revised from 3.3%) in July, the US Bureau of Economic Analysis reported on Friday. This reading came in line with the market expectation.

The annual Core PCE Price Index, the Federal Reserve's preferred gauge of inflation, rose 3.9%, a slightly softer pace than the 4.3% (revised from 4.2%) increase recorded in July. On a monthly basis, the PCE Price Index and the Core PCE Price Index increased 0.4% and 0.1%, respectively. Both of these figures came in below analysts' estimates.

Further details of the report showed that Personal Income and Personal Spending both grew 0.4% on a monthly basis as expected.

Market reaction to US PCE inflation data

The US Dollar struggles to find demand after this report. As of writing, the US Dollar Index was down 0.25% on the day at 105.86. Meanwhile, the 10-year US Treasury bond yield was in negative territory at around 4.55% and US stock index futures were up between 0.5% and 0.7%.

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This section below was published as a preview of the US PCE inflation report at 07:00 GMT.

• The Core Personal Consumption Expenditures Price Index is forecast to rise 0.2% MoM and 3.9% YoY in August.
• The Federal Reserve’s Summary of Economic Projections pointed to one more rate hike in 2023.
• A soft PCE reading could weaken the US Dollar. 

The Core Personal Consumption Expenditures (PCE) Price Index, the US Federal Reserve’s (Fed) preferred inflation gauge, will be released by the US Bureau of Economic Analysis at 12:30 GMT.

What to expect in the Federal Reserve’s preferred PCE inflation report?

The Core Personal Consumption Expenditures (PCE) Price Index, which excludes food and energy, is forecast to rise 0.2% in August on month, matching the increase recorded both in June and July. The annual Core PCE Price Index is seen rising 3.9%, at a softer pace than the 4.2% increase registered in July.

The headline PCE Price Index is expected to grow 0.5% MoM in August, while the annual PCE figure is anticipated to edge higher to 3.5% following the 3.3% increase recorded in July.

The revised Summary of Economic Projections (SEP) published after the September Fed policy meeting showed that policymakers forecast one more rate hike before the end of the year. On an encouraging note, officials forecast more progress on taming core inflation in 2023 than they saw in June projections. "[The] majority of policymakers believe it is more likely than not another rate hike will be appropriate," Fed Chairman Jerome Powell said in the post-meeting press conference.

Meanwhile, Fed Governor Michelle Bowman said that the continued risk of a further increase in energy prices could reverse some of the recent progress on lowering inflation. 

Analysts at TD Securities offer their forecasts for the upcoming PCE data:

“We expect core PCE inflation to register a third consecutive 0.2% m/m increase in August; undershooting the core CPI's stronger 0.3% gain. The y/y rate likely also fell to 3.9%, while we expect the key core services ex-housing series to slow to 0.2% m/m following July's 0.5% surge. Conversely, we look for personal spending to lose speed, rising only 0.2% m/m — a three-month low.”

When will be the PCE inflation report released and how could it affect EUR/USD?

The PCE inflation report is due at 12:30 GMT. The CME Group FedWatch Tool shows that markets are still pricing in a 60% probability that the Fed will hold the policy rate steady for the remainder of the year. This market positioning suggests that the US Dollar (USD) faces a two-way risk heading into the event. 

Generally, investors react to the monthly core PCE inflation reading since it’s not distorted by base effects and paints an accurate picture of the underlying inflation trend by stripping prices of volatile items. However, investors are growing increasingly concerned over rising energy prices since early summer because it makes it more  difficult for the Fed to tame inflation. Hence, a higher-than-forecast increase in monthly PCE inflation could still provide a boost to the USD even if the Core PCE Price Index comes in line with the market consensus.

On the other hand, a soft monthly reading of 0.1%, or even lower, could hurt the USD with the immediate reaction. Since PCE inflation is a lagging data, however, investors might refrain from betting on a steady pullback in the USD. In September, crude Oil prices are up 10%, compared to the 2.2% advance seen in August, suggesting that investors are likely to wait until September inflation data before deciding whether the Fed will deliver one more rate increase before the end of the year.  

FXStreet Analyst Eren Sengezer offers a brief technical outlook for EUR/USD and explains: “EUR/USD suffered heavy losses in the first half of the week and touched its lowest level since early January below 1.0500 before staging a rebound on Thursday. The Relative Strength Index (RSI) indicator on the daily chart climbed above 30, suggesting that the pair’s latest recovery was a technical correction rather than the beginning of a reversal. In the meantime, the pair remained within the descending regression channel coming from mid-July, confirming the bearish bias.” 

Eren also highlights the important technical levels for EUR/USD: “On the upside, 1.0600 (upper limit of the descending channel) aligns as first resistance. If the pair manages to flip that level into support, 1.0660 (20-day Simple Moving Average (SMA), Fibonacci 23.6% retracement of the latest downtrend) could be set as the next recovery target before 1.0790-1.0800 (Fibonacci 38.2% retracement, psychological level). In case EUR/USD fails to clear 1.0660, sellers could retain control. In that scenario, supports could be seen at 1.0500 (static level, psychological level) and 1.0430 (static level from December)."