In the financial markets, inflation is one of the core economic indicators that investors, businesses and policy makers pay close attention to. In the United States, the Federal Reserve, as the central bank of the United States, to achieve the ‘maximum employment’ and ‘price stability’ of the dual mandate. Therefore, inflation data for the Federal Reserve's monetary policy is crucial. And in the many measures of inflation indicators, the Federal Reserve is the most important is known as a core personal consumption expenditure price index (Core PCE Price Index) of the inflation indicators.

What is Core PCE?

Core Personal Consumption Expenditure Price Index (Core PCE) is an inflation indicator published by the U.S. Department of Commerce's Bureau of Economic Analysis (BEA). The index reflects changes in U.S. consumer spending on goods and services, but unlike the general Consumer Price Index (CPI), it excludes fluctuations in food and energy prices, which are highly influenced by external factors (e.g., weather, international conflicts, etc.) and are prone to sharp short-term fluctuations.

Core PCE is primarily used to measure underlying inflationary pressures because it better captures long-term trends in prices. The Fed believes that core PCE more accurately reflects changes in consumers' real purchasing power and demand pressures in the economy, and therefore uses it as an important basis for setting monetary policy.

Why is the Fed more concerned about core PCE?

There are three main reasons why the Fed is concerned about core PCE:

1. more stable price signals: food and energy prices are often affected by global events, and after removing these more volatile items, core PCE provides a more stable inflation signal.
2. Broader coverage of consumer behaviour: The PCE index covers a wide range of goods and services, including healthcare, providing a more complete picture of changes in consumers' actual purchasing power.
3. Historical consistency: Since 2012, the Federal Reserve has officially set 2% as the target inflation rate, and the trend of core PCE has a direct impact on whether or not the Fed adjusts interest rates as well as other monetary policy tools.

Difference between Core PCE and Other Inflation Indicators

In addition to the core PCE, there are several other commonly used inflation indicators in the United States, mainly including:

1. Consumer Price Index (CPI): Released by the U.S. Bureau of Labor Statistics (BLS), it reflects changes in the prices of a basket of goods and services, including food and energy prices. The CPI is the most frequently cited inflation indicator by the general public and the media, but due to its high volatility, the Fed prefers to use the PCE. The CPI is usually ahead of the PCE in terms of release time and therefore has a greater impact on the market. However, PCE is considered to be a more accurate and comprehensive measure of U.S. inflation because it takes into account the ‘substitution effect’ of price changes and better reflects the true behaviour of consumers.
2. Overall PCE (PCE Price Index): Similar to the core PCE, but does not exclude food and energy prices. Although the Fed will also focus on the overall PCE, but the core PCE is considered more reflective of long-term, stable inflation trends.
3. Producer Price Index (PPI): Reflects changes in the prices faced by producers in the sale of goods and services, and is often considered a ‘forward-looking’ indicator of inflation because it shows trends in the cost of production for businesses.

Core PCE Performance in Current Economic Conditions

According to the latest data from the US Department of Commerce, the core PCE price index rose by 3.5% year-on-year in October 2024, down from 3.7%. This data suggests that while inflationary pressures have moderated, they remain above the 2% target level set by the Federal Reserve. Core PCE prices slowed in October after rising 0.4 per cent for two consecutive months, with the figure coming in at 0.2 per cent, in line with expectations and the lowest level since July 2022.

Analysts believe that the U.S. core PCE price index saw its largest monthly increase since April, supporting the Fed's slowing pace of rate cuts after a sharp cut in September, and possibly signalling a cautious approach to rate cuts by the Fed in the coming months. The market now expects the Fed to cut rates at least once at its November and December rate meetings, but the exact policy path will be highly dependent on future economic data, particularly the performance of core PCE.