A shopping cart is seen in a supermarket in Manhattan, New York City, U.S., June 10, 2022. REUTERS/Andrew Kelly/File Photo

By Lucia Mutikani

WASHINGTON (Reuters) -U.S. consumer spending increased by the most in four months in July while services inflation picked up, but economists did not believe the signs of strong domestic demand would prevent the Federal Reserve from cutting interest rates next month against a backdrop of softening labor market conditions.

The report from the Commerce Department on Friday showed mild price pressures from tariffs on imports. Economists said the import duties have been slow to feed through to inflation as businesses are selling stocks accumulated before President Donald Trump's sweeping duties kicked in. Businesses have also been absorbing some of the costs.

"Sticky service sector inflation all point towards a difficult September policy decision in which we expect the Fed to cut rates by 25 basis points," said Joseph Brusuelas, chief economist at RSM.

Consumer spending, which accounts for more than two-thirds of economic activity, rose 0.5% last month after an upwardly revised 0.4% gain in June, according to the Commerce Department's Bureau of Economic Analysis.

Economists polled by Reuters had forecast spending would rise 0.5% after a previously reported 0.3% advance in June.

Motor vehicle purchases led the broad increase in sales, helping to lift outlays on long-lasting manufactured goods by 1.9%. There were also increases in spending on recreational goods and vehicles, clothing and footwear as well as furnishings and durable household equipment. Spending on food and beverages jumped. But outlays on gasoline and other energy goods declined.

Overall spending on goods increased 0.8% after rebounding 0.3% in June. Outlays on services rose 0.4%, matching June's gain, and were lifted by financial services and insurance, healthcare as well as housing and utilities. Spending at restaurants and bars as well as on hotel and motel rooms fell.

Consumption is being supported by low layoffs that are underpinning solid wage growth. Wages increased 0.6% last month, but rising operating costs because of tariffs have left employers reluctant to increase headcount.

Employment gains have averaged 35,000 jobs per month over the last three months through July compared to 123,000 during the same period in 2024, the government reported this month.

A survey from the Conference Board on Tuesday showed the share of consumers viewing jobs as "hard to get" jumped to a 4-1/2-year high in August. Fed Chair Jerome Powell last week signaled a possible rate cut at the U.S. central bank's September 16-17 policy meeting, in a nod to increasing labor market risks, but also added that inflation remained a threat.

The Fed has kept its benchmark overnight interest rate in the 4.25%-4.50% range since December.

IMPORTS SURGE

Economists anticipate inflation will start rising in the second half of the year due to rising business costs and an inventory drawdown in the second quarter. Companies from retailers to motor vehicle manufacturers have warned that tariffs are raising their costs, which economists expect will eventually be passed on to consumers.

The Personal Consumption Expenditures (PCE) Price Index increased 0.2% last month after an unrevised 0.3% rise in June, the BEA said. Goods prices fell 0.1%, pulled down by a 1.7% drop in the costs of gasoline and other energy goods. Recreational goods and vehicles declined 0.9%.

In the 12 months through July, the PCE Price Index rose 2.6%, matching the gain in June.

Excluding the volatile food and energy components, the PCE Price Index increased 0.3% last month, matching the rise in June. Services prices increased 0.3%, the most since February, after rising 0.2% for four straight months. It was fueled by a 1.2% jump in the costs of financial services and insurance.

In the 12 months through July, the so-called core inflation figure advanced 2.9%. That was the largest rise in core PCE inflation since February and followed a 2.8% increase in June. The Fed tracks the PCE price measures for its 2% inflation target.

The solid consumer spending bodes well for economic growth in the third quarter. But the strong demand is pulling in imports, which could blunt some of the boost to gross domestic product from consumer spending.

A separate report from the Commerce Department's Census Bureau showed the goods trade deficit soared 22.1% to $103.6 billion last month as imports jumped $18.6 billion to $281.5 billion. Goods exports dipped $0.1 billion to $178.0 billion.

An ebb in import flows led to a sharp contraction in the trade deficit in the second quarter, which added a record 4.95 percentage points to GDP growth that period.

The economy grew at a 3.3% annualized rate last quarter. GDP contracted at a 0.5% rate in the January-March quarter, weighed down by a sharp deterioration in the trade deficit that was driven by businesses front-running imports at a record pace as tariffs kicked in.

(Reporting by Lucia Mutikani; Editing by Paul Simao and Nia Williams)