US Inflation Drops Not Just Due to Fuel Prices, The Fed Holds Its Breath

The United States central bank has maintained interest rates within the 3.50%-3.75% range during its 28-29 July 2026 meeting. The decision was not unanimous, with three out of twelve FOMC members opting for a rate hike. Fed Chair Kevin Warsh reaffirmed the commitment to bringing inflation towards the 2% target but provided no guidance on subsequent steps.

A day later, the US Bureau of Economic Analysis reported that the Personal Consumption Expenditures (PCE) price index fell by 0.1% month-on-month in June, its deepest decline since April 2020. On an annual basis, PCE inflation slowed to 3.7% from 4.1% in May. Core PCE inflation also rose by only 0.1% monthly, down from 0.3% in May, while the annual figure eased from 3.4% to 3.3%. These figures indicate that price pressures are beginning to subside, although they remain above the Federal Reserve’s target.

According to an analysis in The Economist’s Inflation Tracker, this decline in inflation is not solely attributable to fuel prices. Price pressures are easing across various other goods and services, suggesting a broader slowdown within the US economy. While vehicle fuel was a major contributor following a 10% drop—linked to a temporary ceasefire between the US and Iran—the largest declines after fuel were found in jewellery, communication services, and hotels. These sectors do not require high levels of energy input.

This trend suggests that the easing of inflation is not merely a result of cheaper oil. An index designed to track inflation trends earlier has also dropped from 3.6% to 2.5%. While falling energy prices typically lower production and distribution costs, if energy were the primary driver, the decline would risk being temporary. Such risks are emerging as Brent crude prices rose above US$90 per barrel and US petrol prices exceeded US$4 per gallon.

However, the June PCE composition shows that price weakness is occurring in sectors not directly sensitive to energy costs. The decline in core inflation to 0.1% monthly reinforces the view that price pressures are easing outside the energy sector, even though annual core inflation remains at 3.3%, well above the 2% target.

Interpreting inflation trends is complex. Annual comparisons provide stability but are slow to capture recent shifts, which is particularly problematic during rapid economic changes caused by geopolitical conflicts or shifts in government policy. Conversely, relying solely on monthly data can be misleading due to seasonal adjustments or extreme price spikes in single commodities, such as the surge in egg prices caused by avian flu in late 2024.

To address this, The Economist’s predictive inflation index employs two main adjustments. First, it reweights components of the PCE index; goods and services experiencing extreme price fluctuations are given less weight, similar to the trimmed-mean inflation approach used by the Federal Reserve Bank of Dallas. Components with price changes near the median receive a significantly higher weight, while those in the 10th and 90th percentiles receive much less. This prevents extreme movements in items like eggs or petrol from obscuring the overall inflationary trend. Second, the index gives greater importance to recent data, ensuring that current price movements have a much stronger influence on the index than older data.