Fed’s Preferred Gauge Shows Accelerating December Inflation Trends

Inflation concerns resurfaced in December as the Federal Reserve’s preferred price measure indicated a renewed pickup in underlying price pressures. The latest data from the Personal Consumption Expenditures (PCE) index — the inflation gauge most closely watched by policymakers at the Federal Reserve — suggests that while headline inflation remains far below its pandemic-era peak, progress toward the central bank’s 2% target has slowed.

Understanding the Fed’s Preferred Gauge

Unlike the more widely cited Consumer Price Index (CPI), the PCE price index is compiled by the Bureau of Economic Analysis and reflects changes in the prices consumers pay for goods and services across the entire economy. The Federal Reserve favors PCE because it adjusts for shifts in consumer behavior — for example, when shoppers substitute lower-cost goods for higher-priced alternatives — and it provides a broader measure of spending patterns.

There are two main versions of the index: headline PCE, which includes food and energy prices, and core PCE, which excludes those volatile components to offer a clearer picture of underlying inflation trends. Policymakers tend to focus on core PCE when assessing whether inflation is becoming entrenched.

December’s report showed both headline and core measures edging higher on a monthly basis, signaling that inflationary pressures may not be easing as steadily as hoped.

December’s Acceleration: What the Data Shows

After months of gradual cooling, December data indicated a modest acceleration in price growth. Core PCE rose more firmly than in prior months, while headline inflation reflected persistent increases in services costs, particularly in housing and healthcare.

The uptick suggests that while supply chain normalization and easing goods prices helped tame inflation earlier in the year, service-sector inflation remains sticky. Wage growth, though moderating, continues to support consumer demand — a factor that can keep upward pressure on prices.

On a year-over-year basis, inflation remains well below the highs seen in 2022, when aggressive tightening measures were launched. Still, the December figures indicate that the “last mile” of disinflation may prove more difficult than anticipated.

Why the Federal Reserve Watches PCE Closely

Under Chair Jerome Powell, the Federal Reserve has emphasized a data-dependent approach to monetary policy. The PCE index plays a central role in shaping interest rate decisions made by the Federal Open Market Committee (FOMC).

The Fed’s 2% inflation target is defined in terms of PCE, not CPI. Therefore, when PCE readings accelerate unexpectedly, it can alter expectations for the trajectory of interest rates. Investors closely monitor these reports for signals about whether rate cuts may be delayed — or whether policymakers could even consider renewed tightening.

December’s data complicates the outlook. While not signaling a dramatic resurgence of inflation, the acceleration suggests that premature rate cuts could risk reigniting price pressures.

Services Inflation: The Stubborn Component

One of the most persistent drivers of inflation has been services. Unlike goods prices — which benefited from improved global supply chains and cooling demand — services are more closely tied to domestic wage dynamics.

Housing costs, medical services, and hospitality continue to contribute meaningfully to core inflation. Labor-intensive sectors tend to respond more slowly to interest rate increases, which means the Fed’s previous hikes may take longer to fully filter through these parts of the economy.

This dynamic underscores why policymakers remain cautious. A reacceleration in services inflation could slow the broader disinflation process and keep policy restrictive for longer than markets currently expect.

Market Reaction and Policy Implications

Financial markets tend to react swiftly to PCE releases. Treasury yields often move in response to even small surprises, reflecting shifting expectations about future Fed policy.

In the wake of December’s report, investors recalibrated their outlook for rate cuts. Earlier optimism that the Fed might ease policy rapidly gave way to a more measured expectation of gradual adjustments. Equity markets, which had rallied on hopes of a soft landing and declining rates, displayed increased volatility.

For policymakers, the data reinforces the need for patience. The Fed has repeatedly emphasized that it seeks sustained evidence that inflation is moving durably toward 2% before loosening monetary conditions.

The Broader Economic Picture

Despite the acceleration in December inflation, the broader economy remains resilient. Consumer spending has held up, and the labor market remains relatively strong by historical standards. However, tighter financial conditions continue to weigh on certain interest-sensitive sectors, such as housing and business investment.

The balancing act facing the Fed is delicate. Cut rates too soon, and inflation could reaccelerate. Maintain restrictive policy for too long, and economic growth could falter unnecessarily.

This tension defines the current policy environment. Inflation is no longer spiraling out of control, but it is not yet fully subdued. December’s data serves as a reminder that inflation’s path downward may not be linear.

What Comes Next?

Looking ahead, policymakers will scrutinize upcoming data releases to determine whether December’s acceleration represents a temporary fluctuation or the beginning of a renewed upward trend.

Energy prices, global supply conditions, wage growth, and consumer demand will all play key roles in shaping the inflation outlook. Additionally, external risks — including geopolitical tensions and financial market volatility — could influence both inflation and growth trajectories.

For households and businesses, the implications are significant. Borrowing costs remain elevated relative to pre-pandemic levels, and expectations about future rates affect everything from mortgage decisions to corporate investment planning.

Ultimately, the December PCE report underscores a fundamental reality: defeating inflation is often a gradual and uneven process. While substantial progress has been made since peak price pressures, the latest data highlights the challenges of achieving the final stretch toward the Federal Reserve’s 2% objective.

As 2026 unfolds, all eyes will remain on the PCE index — the Fed’s preferred gauge — for clues about whether inflation is truly under control or poised for another chapter of volatility.