Core inflation rises in February

March 28, 2025

Consumer spending rose just 0.1% in February, failing to recoup all of January’s weather-related decline. The one bright spot was a modest upturn in spending on motor vehicles, that may have been partly inspired by an attempt to beat new tariffs. Elsewhere spending was generally soft, perhaps best exemplified by a sharp decline in spending for meals out and accommodations, which fell 1.4% and has declined at a 7.6% annualized pace over the last three months.

Inflation heats back up

Inflation moved in the wrong direction in February, away from the Fed’s 2% target for headline PCE. The three-month annualized change in core PCE prices rose to 3.6% and the 12-month change climbed from an upwardly revised 2.7% in January to 2.8%. All in, this report suggests we’re heading toward at least a mild bout of stagflation. This is prior to the full effects of tariffs kicking up. 

Personal disposable incomes rose 0.5% in February after adjusting for inflation, buoyed by solid increases in compensation and personal current transfer receipts—payments or credits to persons from government and business. Transfers were boosted by a large increase in premium credits in the health insurance marketplace and business transfers to persons.

There was a large payout for a settlement by a medical device manufactured and a social media company. Those gains are temporary.

A Cautious Consumer

Consumer spending rose only 0.1% in February, after adjusting for inflation, following January’s 0.6% drop. Unseasonably harsh weather in January helped account for the decline then, but a return to seasonally normal weather in February should have allowed a full recovery. The failure of spending to recover, in light of solid growth in real income, suggests that consumers are hunkering down in the face of elevated uncertainty. The personal saving rate rose three-tenths of a percentage point to 4.6%.

Goods spending rebounded, increasing 0.7%, after adjusting for inflation, following January’s 1.7% drop, which was the largest decline since July 2021. Vehicle unit sales improved by half a million units (annual rate) in February, underlying a 1.6% rise in spending on motor vehicles and parts. That only partially reversed January’s 8.8% plunge. Vehicle sales are expected to pick up in March as consumers return to dealer lots to buy ahead of tariffs.

Spending on services cooled overall in February, falling 0.1%, and is up only 0.8% annualized, over the past three months, signaling a material loss of momentum. Food and drink consumed away from home and accommodation accounted for much of the weakness. 

The personal consumption expenditures (PCE) index rose 0.3% in February, the same as in December and January. The year-on-year measure held steady at 2.5% pace in February. However, the three-month annualized change has moved up to 3.9%, even before tariffs begin to impact prices. Inflation is moving away from the Federal Reserve’s 2% target, a development that is likely to keep the Fed on the sidelines for some time.

Core PCE prices, which strip out the volatile food and energy components of the index, rose 0.4% in February, up from 0.3% in January. That translated to a 2.8% increase from a year ago. Momentum in the core PCE price index was even less encouraging. The three- and six-month annualized changes came in at 3.9% and 3.1%, respectively, quite a bit higher than in January.

The PCE super core services index, which also strips out shelter costs and has proven the stickiest, also accelerated. It rose 0.4% in February after rising 0.2% in January. That translates to a 3.3% increase from a year ago. 

The momentum measures of the super core came in hot. The three- and six-month annualized changes rose to 4.1% and 3.7%, respectively. The super core is still running more than one percentage point above the pace in 2019. 

The outlook for inflation over the next several months remains worrisome. New tariffs have been levied at an alarming pace; some have already taken effect. The administration is set to announce new “reciprocal” tariffs next week. Our assessment of effective tariff rates now gets them to their highest level since the 1930s by year-end. Recent updates suggest they could be the highest since the early 1900s, barring a course correction in policy. 

The soft undertone to the spending numbers in today’s report suggests consumers are being cautious. This mirrors the recent rapid deterioration in consumer attitude surveys. Inflation fears and concerns about job security are likely to keep consumer spending growth sluggish until there is more clarity on the economic outlook. All major measures of consumer attitudes have tanked on fears of higher inflation and concerns about job security in recent months. The losses span demographic groups and party affiliation.