Dive Brief:

• Consumer spending rose 0.7% last month even as inflation sped up to the fastest pace in three years, according to data released Thursday by the Bureau of Economic Analysis.
• The personal consumption expenditures index increased 0.4% in May and 4.1% on an annual basis, or more than twice the 2% inflation rate targeted by the Federal Reserve. Core PCE, which excludes volatile food and energy prices, increased 3.4% from one year ago, the BEA said.
• “If the labor market holds, we expect consumers will have the ability to maintain spending patterns,” LPL Financial Chief Economist Jeffrey Roach said in a note.

Dive Insight:

Personal income and disposable income rose at the same 0.7% rate as consumer spending, highlighting resilience in the economy despite weak consumer sentiment and an inflation rate that has exceeded the Fed’s target for more than five years.

Gross domestic product will likely expand during the second quarter by 2.5%, the Atlanta Fed forecast on Thursday, or 0.4 percentage point faster than first-quarter growth.

Solid business spending, underscored by an increase in the shipment of capital goods in April and May, likely fueled the gain in GDP, Roach said.

“Given the growth trajectory, the Fed is rightly focused on price stability and will remain hawkish this summer,” he said.

“If the Iran crisis creeps into the Labor Day timeframe, we have a much higher chance that inflation pressures will seep into other categories and will force the Fed’s hand,” Roach said.

Traders in interest rate futures see 80% odds that the central bank will raise the federal funds rate by the end of 2026 by at least a quarter percentage point from its current range between 3.5% and 3.75%, according to the CME Group’s FedWatch tool. A month ago traders saw a 68% probability of an increase in borrowing costs.

Fed Chair Kevin Warsh at a June 17 press conference repeatedly asserted the determination of policymakers to curb inflation to 2%.

Nevertheless, Fed officials in a median projection this month saw core PCE ending 2026 at 3.3% and 2027 at 2.5%, respectively.

In 2028, core PCE will still remain above the central bank’s target, ending the year at 2.1%, according to the median estimate.

Consumers keep spending even though their sentiments persist well below the level before the U.S. and Israel began air strikes against Iran on Feb. 28.

Confidence among consumers fell last month as prices for gasoline and other goods rose. The Consumer Confidence Index dipped 0.7 points to 93.1, the Conference Board said.