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Economic Commentary

Inflation slows, but price pressures remain elevated for services: Weekly Economic Review & Outlook

April 03, 2023
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As developments on the banking sector settled down in the latest week, economic data returned to center stage, highlighted by the February’s consumer inflation and spending data. Headline consumer inflation fell to its slowest pace since September 2021, but the details suggest little downward pressure on the services side. Core services inflation climbed higher even when excluding soaring housing costs.

Real consumer spending dipped marginally in February, but the level of consumer spending remained strong after January’s surge. The consumer expectations readings in both The Conference Board and the University of Michigan’s consumer confidence surveys remained at levels consistent with an oncoming recession. However, as of yet the concerns expressed in consumer surveys have yet to have a significant impact on spending behavior.

Key Takeaways:

What we learned last week: (pg. 1)

The super core measure is trending up

The super core inflation measure is trending up since mid-2022, showing that inflationary pressures remain strong for services.

Consumer spending falls, but remains strong

Real consumer spending pulled back for the third time in four months but is still strong due to January’s spending spree.

What we’re watching this week: (pg. 2)

April 3: ISM Manufacturing

ISM manufacturing should mimic drop seen in other manufacturing indices

The ISM manufacturing index is expected to drop further below the 50 expansion-contraction line in March as activity slows due a deeper contraction in orders for manufactured goods. The new orders index has turned down three of the last four months as demand weakens broadly. Several regional manufacturing indicators (including the Chicago PMI and the Empire State, Philadelphia Fed and Dallas manufacturing indices) signaled continued contraction in activity in March. The Chicago PMI directionally has a particularly tight fit with the ISM manufacturing index over time, though it records larger swings at times.

April 5: ISM Services

ISM services should still expand, but slower

ISM services should remain in expansion in March but show a slower pace of growth than February, dropping to 54.2. Demand for services remains solid and is keeping hiring and growth within the sector buoyant. February’s consumer spending breakdown showed further preference for spending on services compared to goods, a continued reversal of pandemic trends. The employment component of the services index is expected to ease slightly in March, as employment figures remain strong, but show signs of cooling.

April 7: Nonfarm Payrolls

Continued strong job growth and a tight labor market

March’s payroll gain should remain solid at 230,000, but this would be a notable slowdown from the very strong pace of hiring in the past two months. Job openings are still very high, and most firms are holding onto workers, but there have been signs that more businesses are reducing the pace of new hires to control costs. This should result in a slower pace of job growth going forward. After rising in February, the unemployment rate should remain steady at 3.6 percent in March — still a very low level and indicative of continued tight labor market conditions.

Analysis: Services inflation remains sticky, and consumers continue to spend

The headline and core PCE price indices encouragingly came in a bit softer than expected, both rising 0.3 percent in February. This allowed the year-on-year pace for both to decelerate further — down to five percent for the overall PCE and 4.6 percent for core PCE price inflation.

However, disinflation is coming almost entirely from the goods side as the year-on-year inflation rate for core goods fell to 2.3 percent – more than five percentage points lower than its cycle peak. Core services inflation continued to climb, led by housing inflation which rose to its highest level in over 40 years. Price pressures for services are broad-based as core services less housing — the super core price measure — also climbed, rising to 4.4 percent on a year-on-year basis from 4.3 percent in January and is only down slightly from the 4.7 percent peak in November 2021. This supports Chairman Powell’s recent commentary that we have seen little disinflation in this key core services inflation reading. As such, Fed officials are likely to continue to be concerned that the stickiness in core services could prevent inflation from cooling sufficiently, with tightness in the labor market continuing to place upward pressure on wages and prices in the service sector.

Largely in line with expectations, spending and income in nominal and real terms were softer in February, following the ebullient gains in January that were underpinned by the strong advance in employment for the month. Adjusted for inflation, real consumer spending fell 0.1 percent in February, which is just a modest retracement from the 1.5 percent jump in January. This pace of consumer spending should keep real GDP growth on track for a solid first quarter gain of around 2.5 percent.

Within the consumer spending details, real consumer spending on services fell by 0.1 percent, marking the first decline in a year. However, it followed an outsized 0.7 percent gain in January so, again, the level of spending on services remains quite high and is three percent above where it was a year ago. We suspect growth in services expenditures will rebound in March and maintain a strong pace through the summer despite the concerns from consumers evident in March’s consumer confidence report, where consumer expectations climbed a little but remained at a level consistent with recession expectations as they have for 12 of the last 13 months. That said, we will be watching spending data closely for any signs that consumers are starting to pull back, especially with services inflation remaining elevated.


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