By Lucia Mutikani
WASHINGTON (Reuters) - U.S. consumer spending rose moderately in February, and while inflation cooled, it remained high enough to possibly allow the Federal Reserve to raise interest rates one more time this year.
The slowdown in consumer spending reported by the Commerce Department on Friday followed the largest increase in nearly two years in January. That, together with February's small gain put consumer spending on track to surge this quarter after growing at its slowest pace in 2-1/2 years in the fourth quarter.
Economists boosted their economic growth estimates for the first quarter to as high as a 3.25% annualized rate. Stronger growth this quarter is expected to help to ease worries of a credit crunch, triggered by the recent collapse of two regional banks, and keep the Fed focused on taming high inflation.
"A credit crunch is never a good thing, but a credit crunch when the economy is growing at a 3% pace is far less threatening than one when the economy is near stall speed," said Chris Low, chief economist at FTN Financial in New York. "The combination of strong growth expectations and time before the May meeting mean policy focus should be back on inflation."
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased 0.2% last month. Data for January was revised higher to show spending vaulting 2.0% instead of the previously reported 1.8%. January's increase was the biggest since March 2021. Economists polled by Reuters had forecast consumer spending would gain 0.3%.
Consumers increased spending on housing and utilities as well as on healthcare, but cut back on spending at restaurants, bars and hotel accommodation. Overall, services spending rose 0.2% after advancing 1.2% in January.
Outlays on long-lasting manufactured goods dropped 1.4% as a plunge in purchases of motor vehicles offset gains elsewhere. Spending on nondurable goods increased 0.9%, reflecting higher gasoline prices. There were also increases in spending on pharmaceutical products as well as food and beverages.
Adjusting for inflation, consumer spending dipped 0.1%. The so-called real consumer spending surged 1.5% in January. Even if real consumer spending remained soft in March, that would not change its sharp upward trajectory for the first quarter, economists said. JPMorgan (NYSE:JPM) raised its first-quarter GDP growth estimate to a 3.25% rate from a 2.5% pace. Goldman Sachs (NYSE:GS) bumped up its estimate by 0.2 percentage points to a 2.4% pace.
The economy grew at a 2.6% pace in the October-December quarter. But financial market stress has amplified the risk of a recession later this year. Banks have tightened lending standards, which could make it harder for households to access credit, weighing on demand.
"The economy looks strong today, but the outlook is still in doubt as banks may pull back on the credit they provide to help the economy grow," Christopher Rupkey, chief economist at FWDBONDS in New York.
Stocks on Wall Street were trading higher. The dollar rose against a basket of currencies. U.S. Treasury yields fell.
INFLATION COOLING
The Fed last week raised its benchmark overnight interest rate by a quarter of a percentage point, but indicated it was on the verge of pausing further increases in borrowing costs in a nod to financial market turmoil. The U.S. central bank has hiked its policy rate by 475 basis points since last March from the near-zero level to the current 4.75%-5.00% range.
The personal consumption expenditures (PCE) price index increased 0.3% last month after accelerating 0.6% in January. Energy prices decreased 0.4%, while food rose 0.2%.
In the 12 months through February, the PCE price index advanced 5.0%. That was the smallest year-on-year gain since September 2021 and followed a 5.3% increase in January.
Excluding the volatile food and energy components, the PCE price index climbed 0.3% after increasing 0.5% in January. The so-called core PCE price index rose 4.6% on a year-on-year basis in February after gaining 4.7% in January. The Fed tracks the PCE price indexes for its 2% inflation target.
According to economists' calculations, core services less housing, which is being closely watched by Fed officials, rose 0.2% after gaining 0.5% in January. On a year-on-year basis, this so-called super core measure is estimated to have increased 4.6% in February.
"Another quarter-point rate hike in May is still a good bet, assuming the banking stress continues to ebb," said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto.
There was more encouraging news on the inflation front. A survey from the University of Michigan on Friday confirmed that consumers expected inflation to subside over the next 12 months.
The survey's near term inflation expectations fell to 3.6% in March, the lowest reading since April 2021, from 4.1% in February. Long-run inflation expectations were unchanged at 2.9% for the fourth consecutive month.
While consumers were less worried about inflation, they grew more concerned about the economy's prospects.
According to the University of Michigan, the banking sector turmoil had a limited impact on consumer sentiment, which logged its first decline four months. Sentiment deteriorated sharply among lower-income, less-educated and younger consumers as well as consumers with the top tercile of stock holdings.
With personal income growth slowing to 0.3% in February as wage gains cooled to 0.3% from a heady 0.9% in January, the deterioration in sentiment does not bode well for consumer spending, though the correlation between the two has weakened.
The personal saving rate climbed to 4.6% from 4.4% in January. Wells Fargo (NYSE:WFC) estimates that households have just under $800 billion in excess savings and believes the capacity of excess savings to impact spending peaked in mid-2021.
"It is income that is becoming the consequential driver of consumption," said Shannon Seery, an economist at Wells Fargo in New York. "It remains our baseline expectation that as financial conditions tighten and demand slows, firms more broadly will be forced to freeze hiring and eventually layoff workers amid decreased profitability."