Inflation over 3% may mean higher interest rates, but July spending and wages are soft

After a weak retail sales report earlier in the month, Thursday had the Commerce Department’s income and spending report for July , which would give an indication how the consumer side of the economy looked like for the start of the 3rd quarter of 2026.

Consumer spending rose in July at the slowest pace in seven months, suggesting the U.S. economy lost a little steam after the end of the 2026 World Cup and start of the third quarter.

Personal spending increased a mild 0.2% last month, the government said. Americans spent less on goods for the second month in a row after splurging in the spring.

Lower gasoline prices last month made spending look weaker than it really was, but households also had to rebuild savings after using rainy-day funds to cope with a surge in inflation this year.

Consumer spending is the main engine of the U.S. economy. Spending in the second quarter grew at a surprisingly robust 3.5% annual pace, adjusted for inflation, after a meager 0.5% increase in the spring.

That 3.5% increase in consumer spending for Q2 is post-inflation, which translated into an annualized increase of nearly 9% before inflation, or around 0.75% a month. So a 0.2% increase is quite a deceleration from that standpoint.

On the positive side, the same report said American incomes were up by 0.4% for July, which meant the US savings rate rose to 3.0%. That’s the first time the savings rate went up in 6 months, and is the highest level since March (although it’s still among the lowest levels in 20 years).

But if you dig into the actual report itself, you find out that most of that income increase was outside of wages and other compensation people get from work.

Total wages and salaries only rose by 0.3% for July, and are only up 3.5% overall in the country in the last 12 months. And with gas prices heading back up in August, does real consumer spending and inflation-adjusted wages take a step back at the same time, and put a limit on Q3 growth?

In the wake of that income and spending report, questions in the financial media turned to what effect these numbers will have on Federal Reserve policymakers when they meet in 3 weeks.

The Personal Consumption Expenditures (PCE) index rose 3.3% in July [over 12 months] on a "core" basis, which excludes volatile food and energy prices. That was in line with expectations and the same level as June. Month over month, prices rose 0.2%, also in line with expectations and up from 0.1% in June.

The monthly increase suggests inflation is rising at a mild rate (from Jake: It WAS rising at a mild rate through July. Maybe not so much now). New York Fed president John Williams has said that if inflation on a monthly basis, as measured by PCE, comes in at 0.2% or lower, that would indicate inflation is coming back down to the Fed's 2% target on its own, implying the Fed would not need to raise rates.

Boston Fed president Susan Collins said Tuesday that she was content to hold rates steady at the last meeting, but she would need to see evidence that inflation is dropping to continue holding rates.

Absent that, Collins said it would be appropriate to raise rates "soon" to ensure the Fed gets inflation back down in a reasonable time frame.

It’s noteworthy that we won’t see the August income and spending report with the Fed’s preferred PCE measure until after that September Fed meeting. And the Fed meeting after that one is not scheduled until late October, after many Americans will have voted in the 2026 midterms.

One month does not make a trend, but between the loss of jobs, mediocre spending figures and low wage growth, it sure seems like the 3rd Quarter of 2026 got off to a slow start for the US economy. I know the Atlanta Fed is still claiming the data indicates GDP growth is closer to a boom than a recession, but I think those projections will decline quickly if August’s data is as lame as what we’ve seen in July.