Flaws in the PCE index are set to get a fix. Here's what that means for inflation and interest rates.
Up-and-down-and-up-again gas prices have a big effect on inflation in the short run.
The inflation tracker that exerts the biggest influence on the actions of the Federal Reserve is getting a makeover just as a divided central bank weighs whether to raise U.S. interest rates this fall.
The upshot: The redo to the Fed's favorite price gauge, the so-called core PCE index, is likely to show inflation rising a little more slowly this year than previously reported.
The estimated reduction could range from 0.2 to 0.3 percentage points. So the current 3.4% yearly increase in the core PCE index for the 12 months that ended in May could be reduced to 3.2% or even 3.1%.
Enough to make Americans feel better? Undoubtedly not. Enough to make a difference in what the Fed does? Probably not, but it would give Fed officials who want to hold off on raising interest rates more ammunition.
Let's unpack.
Focus on the core
The Fed's preferred inflation gauge is the personal consumption expenditures price index, which is considered more accurate than the better-known consumer-price index.
Fed officials and Wall Street investors especially focus on what's known as the core rate, which omits food and energy costs and is viewed as a better predictor of long-term trends in U.S. inflation.
How come? Energy prices in particular can gyrate wildly in the short run, making the underlying inflation rate look higher or lower than it really is.
This precise scenario has been playing out this spring and summer, since the start of the U.S. conflict with Iran.
The cost of West Texas crude oil soared 73% to as high as $113 a barrel in early April, from $65 before the war broke out at the end of February.
The price of oil then fell to as low as $68 a barrel in early July when the U.S. and Iran tried to negotiate a peace agreement, only to go back up to $86 this week after hostilities resumed.
The yearly rate of inflation has shown a similar seesawing pattern.
The main PCE price index leaped to a three-year high of 4.1% in the 12 months that ended in May, up from 2.9% in February.
Now it's expected to slow to 3.7% when the June PCE index is published next week. Where it goes after that will depend in large part on whether the U.S. conflict with Iran gets worse or the two sides finally settle matters.
In any case, these big fluctuations in the main PCE index tied to oil prices explain why the Fed pays much closer attention to core rates of inflation.
Let's be clear: The core PCE index also shows inflation rising - and rising too fast for the Fed's taste. That's true under the new method and the old one.
Regardless of which PCE index is used, the Fed has fallen way short of its goal. The central bank is aiming to bring the annual rate of inflation down to 2%.
That brings us to the pending changes in the PCE index.
Longstanding problems
The Bureau of Economic Analysis, author of the report, plans to change how it measures prices in three categories that influence the core PCE rate:
-- Portfolio-management fees
-- Computer software
-- Legal services
Start with portfolio-management fees - basically the cost investors pay firms like Vanguard and Fidelity to manage their investments.
The cost of these services go up and down depending on whether stocks go up or down, hardly a sensible way to measure price changes. When the S&P 500 surges, so does the estimated inflation arising from investor fees for financial advice.
The new formula to determine these investment prices will be less dependent on swings in stock markets.
Under the old formula, the government estimates that fees for financial advice have jumped 22% in the past year. But how many people are really paying investment advisors 22% more now than they paid last year?
The new approach will reduce the yearly rate of increase in portfolio-management fees to around 13%, Oxford Economics estimates.
The old computer-software index is due for a refresh, too. The new price measure will give more weight to gaming and information technology for businesses, two categories that have grown in importance.
Both of these categories show computer-related inflation running more slowly than previously reported.
The old computer-software index showed prices rising at a record 17% yearly pace, dwarfing any prior increase. Historically software prices tend to decline.
The new way of measuring these prices would show an annual increase closer to 10% to 11%, but that's also unusually high. Some analysts caution the new measure might still overestimate inflation tied to computer software.
How come?
Much of the spending is on artificial intelligence, a technology that improves the quality of software. Qualitative improvements in any product or service are deflationary - that is, they reduce inflation over time.
The final category, the cost of legal services, has been a trouble spot for years.
The BEA previously derived its legal data from an unpublished survey in the consumer-price index that had an unusually small sample size.
The CPI estimate of legal costs had becoming increasingly "erratic" since it was last made publicly available in 2024, the BEA said, and the agency was unable to corroborate its findings via other sources.
Earlier this year, the BEA switched to a different price gauge for legal services in the producer-price index that has proved to be more consistent. But the sudden and unpublicized switcheroo stunned Wall Street analysts and caused a bit of a mini controversy.
Inflation watchers in the private sector said the BEA move was justified, but they faulted the agency for not giving the public a heads up, even for such a nerdy statistical thing.
This time around, the BEA gave plenty of notice. The agency announced the pending changes to the PCE index on June 24, with the changes to officially take effect on Sept. 30.
In any case, the new approach to measuring the cost of legal services could actually add slightly to inflation, analysts say.
Political interference?
Why do all this now?
The firing last year of the chief of the Bureau of Labor Statistics by President Donald Trump sparked worries about undue political interference in key government statistics agencies.
Yet Wall Street analysts who closely follow the inflation reports say the problems have long been recognized and the changes are overdue.
"The timing of these revisions and their impact at a pivotal time for Fed policy may raise suspicions of bias or political influence in the statistics, but that's incorrect," wrote Michael Pearce, chief U.S. economist at Oxford Economics.
The head of the BEA, what's more, is not an ally of Trump. Vipin Arora was named director in 2022, during the term of President Joe Biden.
The rate of inflation in the U.S., meanwhile, is too still high, no matter which method is used to calculate the PCE index.
"Core PCE would still be well above 2% even if we exclude special factors that are likely temporarily boosting inflation," Bank of America economist Aditya Bhave wrote.
-Jeffry Bartash
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
July 22, 2026 11:44 ET (15:44 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
Comments