WASHINGTON (Reuters) – US consumer spending increased solidly in January amid higher prices, and the dragging Middle East conflict threatens to add to inflation, bolstering expectations that the Federal Reserve would not resume cutting interest rates before September.
Despite the slightly larger-than-expected increase in spending reported by the Commerce Department, other data hinted at downside risks to the economic outlook after gross domestic product growth slowed at a sharper pace than initially thought in the fourth quarter.
Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, were unchanged in January and consumer sentiment ebbed in early March. Consumer spending barely rose when adjusted for inflation.
Following in the wake of unexpected job losses in February, the reports pose a dilemma for the US central bank.
Economists expected the Fed to keep its benchmark overnight interest rate in the 3.50%-3.75% range next Wednesday, and signal rate cut delays. Financial markets anticipate a single rate reduction this year in September.
"We now see a steep rise in inflation and weaker economic activity in the second quarter due to the spike in gasoline and energy prices, weaker exports as the rest of the world reels from the disruptions, and an erosion in business confidence," said Kathy Bostjancic, chief economist at Nationwide.
Consumer spending, which accounts for more than two-thirds of economic activity, increased 0.4% after advancing by the same margin in December, the Commerce Department's Bureau of Economic Analysis said. Economists polled by Reuters had forecast consumer spending advancing 0.3%.
Real consumer spending edged up 0.1% in January.
Nominal spending was driven by outlays on healthcare, housing and utilities as well as financial services and insurance, due to higher prices. There was increased spending on food, recreational goods and vehicles, and furnishings and durable household equipment, reflecting the pass-through from tariffs.
Spending on discretionary services, including food at restaurants and bars as well as hotel and motel stays, dropped, a sign of caution among households. Growth in outlays on recreation and transportation services slowed. Spending on clothing and footwear declined.
The BEA is still catching up on data releases following delays caused by last year's government shutdown.
The longest-ever shutdown, which weighed on government spending, contributed to GDP growth rising at only a 0.7% annualized rate in the fourth quarter.
That was a sharp downward revision from the previously estimated 1.4% growth pace and reflected downgrades to last quarter's estimates of consumer spending, exports, state and local government structures investment as well as business spending on intellectual products and factory construction.
The economy grew at a 4.4% rate in the third quarter.
GASOLINE PRICES ARE SOARING
With the US-Israeli war against Iran boosting oil prices, a cooling in consumer spending is likely. Retail gasoline prices have soared more than 21% to $3.63 per gallon since the conflict started, data from motorist advocacy group AAA showed.
The war is also causing volatility on the stock market, with economists warning of wealth reduction among higher-income households that could force some to cut back on spending. High-income households are the main drivers of consumer spending and the overall economy. Lower-income households have already scaled back as tariffs raised prices for goods and will be disproportionately affected by expensive gasoline.
Income increased 0.4%, lifted by wages and annual cost-of-living adjustment for seniors and recipients of Social Security Administration benefits. Income at the disposal of households jumped 0.9%. The saving rate increased to a six-month high of 4.5% from 4.0% in December.
Consumers are expected to receive a windfall from higher tax refunds as President Donald Trump's tax cuts come into effect.
"Consumers will need to balance rising income tax refunds and rising gasoline prices and inflation rates in the months ahead to sustain their real spending growth," said Scott Anderson, chief US economist at BMO Capital Markets.
Stocks on Wall Street were lower. The dollar rose against a basket of currencies. US Treasury yields rose.
INFLATION IS RUNNING HIGH
Inflation was already elevated before the war, largely because of Trump's import duties. The Personal Consumption Expenditures price index increased 0.3% after rising 0.4% in December, the BEA said. There were big increases in the prices of furnishings and durable household equipment, and recreational goods and vehicles.
Services inflation increased strongly, driven by healthcare and transportation services. In the 12 months through January, PCE inflation advanced 2.8% after rising 2.9% in December.
Excluding the volatile food and energy components, the PCE price index rose 0.4% after a similar gain in December. Core PCE inflation climbed 3.1% year-on-year, the largest gain since March 2024, after rising 3.0% in December. Oxford Economics estimated that the Iran war would add at least 0.3 percentage point to headline inflation in March through gasoline prices.
"There will be some impact on core prices via higher airfares, and the broader cost-push effects from higher transport prices, but that is sensitive to how long the conflict and elevated energy prices persist," said Michael Pearce, chief US economist at Oxford Economics.
Other data from the Commerce Department's Census Bureau showed core capital goods orders were unchanged in January after increasing 0.8% in December. Economists had forecast orders for these goods rising 0.5%. Shipments of core capital goods fell 0.1% after increasing 1.0% in December.
Orders for durable goods, items ranging from toasters to aircraft meant to last three years or more, were also unchanged after falling 0.9% in December. Durable goods shipments increased 0.6%.
Spending on equipment could get a lift from the war, as rising crude prices spur domestic oil drilling. That could offset some of the anticipated drag on consumer spending.
"For a net exporter like the US, we expect the impact of the oil price shock to be muted, although initially it could be a drag as households' purchasing power immediately takes a hit, while any boost to investment could take a little longer to feed through," said Paul Ashworth, chief North America economist at Capital Economics.