Consumer spending in the United States experienced a stall in May, reaching the lowest growth rate of the year due to persistently high inflation. According to a news release by the U.S. Bureau of Economic Analysis (BEA), personal consumption expenditures (PCE) only increased by 0.1 percent in May, mirroring the growth rate seen in March. In comparison to the previous year, consumer spending rose by 3.8 percent in May 2023, marking the lowest growth rate of the year and a decline from the peak of 5.4 percent in January.
The stagnation in consumer spending coincides with elevated inflation rates. In May, the year-on-year Consumer Price Index (CPI), which measures annual inflation, stood at 4 percent. Inflation has remained at or above 4 percent for 25 consecutive months since April 2021.
The 4 percent inflation rate in May is double the target rate set by the Federal Reserve, which aims for an annual inflation rate of 2 percent. During inflationary periods, the purchasing power of money diminishes, leading to changes in consumer spending habits as individuals opt to spend less.
In terms of dollar value, PCE increased by $18.9 billion in May. This included a $52 billion increase in spending on services and a $33.1 billion decrease in spending on goods. The leading drivers of the increase in service spending were healthcare (particularly outpatient services), other services (with international travel as the main contributor), and transportation services (primarily air transportation). On the other hand, spending on goods saw the largest decrease in motor vehicles and parts (led by new light trucks) and gasoline and other energy goods.
The impact of interest rates also plays a role in consumer spending. Since March 2022, the Federal Reserve has raised its benchmark interest rates by 5 percentage points in an effort to curb inflation. This has resulted in the current range of 5 percent to 5.25 percent, the highest since 2007. Higher interest rates increase borrowing costs, reducing disposable income and consequently limiting consumer spending growth.
Although the Federal Reserve has paused interest rate hikes, there are indications of future increases. Fed Chair Jerome Powell stated that “nearly all” participants in the policy-making Federal Open Market Committee (FOMC) expect it to be appropriate to raise interest rates further by the end of the year.
Consumer spending holds significant importance for the growth rate of the United States as it contributes a significant portion to the gross domestic product (GDP). In March 2023, consumer spending accounted for 68.37 percent of U.S. GDP.
Despite a general sense of optimism regarding the U.S. economy, consumers are approaching spending with caution. According to a report by McKinsey, consumer spending remains lower than it was a year ago across all age and income groups. Real spending declined for the first time in over two years, dropping by 0.7 percent in comparison to the previous year. McKinsey attributes this cautious behavior to consumers wanting better value for their money due to the inflationary environment, where their purchasing power is reduced. As a result, many customers are opting to trade down by switching from expensive or high-volume items to cheaper or low-volume alternatives. Among high-income millennials, 89 percent engaged in trading down, a higher percentage compared to 58 percent among high-income baby boomers.