Federal Reserve faces inflation gauge split as core PCE outpaces CPI

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Fed inflation gauge split

Highlights

PCE inflation for April rises to 3.8% from 3.5% and core PCE to 3.3% from 3.2%, both above the Federal Reserve's 2% target.
The gap between core PCE (3.3%) and core CPI (2.8%) is unusually wide, occurring only 11% of the time since 1990 per Bank of America.
Strong AI-driven capital expenditure, estimated at $800 billion this year, and food services put sustained upward pressure on core PCE inflation.

April inflation data deepens policy challenge

As reported by Reuters, the Bureau of Economic Analysis on Thursday releases April personal consumption expenditures data showing headline PCE inflation rising to 3.8% from 3.5% in March, while core PCE edges up to 3.3% from 3.2%. The figures match expectations, but they keep inflation well above the Federal Reserve's 2% target and leave policymakers with little room to ease policy.

The gap between core PCE and core CPI is now especially notable, with core CPI running at 2.8%. Economists say that is an unusual pattern, because core PCE has only exceeded core CPI around 11% of the time since 1990, according to Bank of America.

PCE and CPI measure price pressures differently. PCE covers a broader set of households and also includes spending made on behalf of consumers, such as employer health insurance payments, while CPI focuses on urban households.

President Donald Trump's tariffs and the Iran war are also seen extending the period of above-target inflation. Annual headline and core PCE and CPI readings have already remained above 2% for more than five years.

AI spending and food categories add pressure

One reason for the divergence may be the AI investment boom. Dean Maki, chief economist at hedge fund Point72, says computer software and accessories carry a much larger weighting in core PCE, and that category is rising at an annual rate of about 14% as companies ramp up AI-related capital spending.

If forecasts for about $800 billion in AI capital expenditure this year prove accurate, as Morgan Stanley estimates, that source of price pressure is unlikely to fade soon. Food classification also matters, because core CPI excludes all food purchases while core PCE still captures some food services consumed off premises; that category rises 3.6% in April, Maki notes.

Maki writes that core PCE inflation appears likely to remain further above target than core CPI in the coming months. That may help explain why Warsh indicates openness to trimmed-mean inflation measures published by the Dallas and Cleveland Federal Reserve banks, which filter out extreme price moves.

The debate also highlights uncertainty over the Federal Reserve's inflation benchmark. While core PCE has long been treated as the practical guide to the 2% target, the central bank's website defines the goal using the annual change in the overall PCE price index, a lack of clarity that could complicate policy communication and raise fresh concerns about Federal Reserve independence.

In our earlier coverage of the U.S. April PCE inflation report, we noted that the headline PCE price index rose 0.4% on the month, lifting the annual rate to 3.8%, while core PCE held at 3.3% year over year. We also highlighted that despite some cooling in monthly readings, inflation remained well above the Fed’s target, supporting expectations the central bank would stay cautious on rate cuts as growth and consumer spending sent mixed signals.

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