US inflation remains elevated, complicating the Fed's ability to cut rates

US inflation, measured by the gauge favored by the Federal Reserve, remains well above the Fed’s 2% target even before a recent surge in energy prices. That persistence could complicate any plan by the central bank to cut rates.

PCE inflation stays above target

A report dated April 9 from the US Department of Commerce showed the Personal Consumption Expenditures (PCE) price index rose 2.8% in February from a year earlier. The core PCE index, excluding energy and food, rose 3%.

Both readings matched analysts’ forecasts but were well above the Fed’s 2% annual inflation target. Compared with January, core PCE growth slowed by 0.1 percentage point, while overall PCE growth remained unchanged.

On a month-over-month basis, both core and overall PCE rose 0.4% from January, in line with expectations.

Growth softens; consumer spending rises

The Commerce Department report also pointed to softer GDP growth, reflecting signs of an economy at risk of slipping into stagnation. Real GDP growth—annualized after stripping seasonal factors to reflect the year-ago period—was 0.5% in Q4 2025, down from 0.7% in the second estimate and 1.4% in the initial release. For all of 2025, US economic growth was still 2.1%.

Consumer spending rose 0.5% in February, while personal income fell 0.1% month over month. Analysts had forecast spending up 0.6% and income up 0.4%.

Energy shock raises inflation risk

The February price readings were reported before the US and Israel attacked Iran, meaning they do not reflect the sharp oil-price surge after the conflict began. Compared with pre-war levels, Brent crude futures in London have risen about 36%.

The report is therefore a snapshot of the economy before the war. Higher oil prices could intensify inflationary pressures in the US economy, which may show up in the CPI report due on April 10, according to the Labor Department.

Fed outlook: cautious on rate moves

Fed officials generally discount short-term energy-price volatility, viewing it as temporary rather than a sign of broader inflation trends. However, recent Fed speakers have conveyed caution on rate moves, saying they want to observe more data before making a decision.

The minutes of the March Fed meeting, released this week, showed policymakers weighing both sides of the dual mandate—stabilizing prices and keeping unemployment low. Members remained inclined toward a rate-cut scenario this year, though some considered keeping policy rates higher for longer.

US inflation has been above the Fed’s target for five years, though officials have said they remain confident inflation is gradually moving lower. Markets currently expect the Fed to hold rates in 2026 amid ongoing inflation pressures, supported by a weakening but still positive labor market that keeps unemployment steady.

Labor market: claims rise but remain within recent trends

The Labor Department’s weekly unemployment claims report released on April 9 showed initial claims for unemployment benefits at 219,000 in the latest week. That was up 16,000 from the prior week and above the 210,000 consensus, but broadly in line with recent trends.

Stagflation concerns highlighted

David Russell, Chief Strategist at TradeStation, said the combination of inflation readings in line with expectations and weaker income—along with another downward revision to GDP growth—suggests stagflation risks are higher than anticipated, even before the Iran conflict.