Fed’s Favored Inflation Measure Posts Largest Annual Increase in Three Years

The Personal Consumption Expenditures (PCE) price index increased 0.7% in May, as the economy continues to absorb tariff impacts and Iran war-related disruption. Excluding food and energy (so-called “core inflation”), the headline PCE price index increased by 0.3%, according to the latest report from the Bureau of Economic Analysis.
Year-over-year, the PCE price index increased 4.1%; excluding food and energy, it went up by 3.4%.

The data comes as mortgage rates remain elevated, and the Federal Reserve continues to hold off on rate cuts after previously projecting a handful for 2026.

Navy Federal Credit Union Chief Economist Heather Long noted that the 4.1% PCE inflation was “the highest inflation in three years and it’s due largely to the war in Iran (and its) impact.”

Also on the rise, the report showed a 0.7% increase ($156.1 billion) in May’s PCE, reflecting increases of $61.8 billion and $94.3 billion in spending for goods and services, respectively.

“Core PCE inflation (excluding food and energy) rose to 3.4%, the highest since Fall 2023. This is painful for the middle-class and moderate-income Americans,” Long continued. “The monthly gain (0.4%) was a bit softer than expected, but the key will be how fast does inflation cool this summer?”

For the housing market, the inflation picture compounds an already difficult environment.

Housing starts hit a six-year low in May, clocking in at a rate of 1,177,000—down 15.4% from April and 8.7% year-over-year. National Association of Home Builders Chairman Bill Owens pointed to elevated mortgage rates, affordability challenges and cautious buyers as factors continuing to weigh on demand for new homes.

Federal Reserve members meet July 28-29 for their next decision on rate cuts.

During the most recent Federal Open Market Committee (FOMC) meeting on June 17, the Summary of Economic Projections (SEP) showed median projections for real GDP growth of 2.2% this year and 2.3% next year. Total PCE inflation is projected to run at 3.6% in 2026 and 2.3% in 2027. The unemployment rate is projected at approximately 4.3%. The median participant sees the appropriate federal funds rate at 3.8% at year’s end and 3.6% at the end of next year.