Inflation Cools in July But Consumer Spending Declines

WASHINGTON — July’s economic data paints a complex picture for American families: inflation cooled modestly to 3.4% year-over-year, but consumer spending unexpectedly declined by 0.6% — the biggest drop in over a year — as households grapple with elevated costs from the Iran war, high mortgage rates, and prices that continue to outpace wage growth.

Cooling Inflation, Persistent Pressures

Consumer prices rose 3.4% in July from a year ago, down slightly from 3.5% in June, according to the Labor Department. On a monthly basis, prices rose just 0.1% from June to July. Core inflation, which excludes volatile food and energy prices, slipped to 2.5% from a year ago — matching a post-pandemic low reached before the Iran war began.

Gasoline prices fell 2.9% from June to July, and grocery prices declined 0.1% month-over-month. Lettuce prices plunged more than 16% in July after a food-borne illness outbreak prompted a recall of iceberg lettuce from Mexico. Yet gas remains 25% higher than a year ago, and groceries are 2.7% more expensive than a year earlier.

“America still has an inflation problem, but there are encouraging signs that price pressures outside of the gas pump are easing,” said Heather Long, chief economist at Navy Federal Credit Union.

However, consumer prices have risen faster than wages for the past four months, underscoring the challenges many Americans face affording necessities such as rent and utilities.

Consumer Spending Slumps

Americans unexpectedly cut their spending in July by the biggest amount in more than a year, according to Commerce Department data. Retail sales fell 0.6% last month — the biggest drop since May 2025 — following a revised gain of 0.2% in June. Economists had projected a small increase.

The decline came after a notable bump in spending in April and May as Americans dipped into government tax refunds. Online sales fell 2.2% from June, when they were fueled by Amazon’s Prime Day event, and motor vehicle and parts dealers saw a 1.8% drop.

“American consumers are showing signs of fatigue,” Long said. “July retail sales were disappointing on all levels.”

There were bright spots: clothing and accessories stores, furniture and home furnishing stores, and building material merchants all posted gains, and restaurants registered a healthy 0.5% increase.

“Though the latest numbers warrant a downgrade to the spending forecast, it’d be premature to write off the consumer,” said Bernard Yaros, lead U.S. economist at Oxford Economics, noting the job market is “broadly balanced” and wealthy households continue to spend.

Housing Market Stays Stuck

Sales of previously occupied U.S. homes fell 1.7% in July to a seasonally adjusted annual rate of 4.06 million units, the National Association of Realtors reported. The U.S. median sales price increased 2% from a year earlier to $434,100, and home prices have risen on an annual basis for 37 consecutive months.

“No one who has a home already can afford to sell it,” said Carl Weinberg, chief economist at High Frequency Economics. “People with ultra-low COVID-era mortgages cannot afford to give them up. If no one is selling, no one can be buying, and inventories are low.”

The 30-year fixed-rate mortgage fell slightly to 6.67% this week — the first decline in six weeks — but remains well above the 6.58% average from a year ago, according to Freddie Mac.

Wholesale Inflation and Labor Market

Wholesale inflation also showed signs of cooling. The producer price index rose 4.7% in July from a year ago, down from 5.5% in June, according to the Labor Department. On a monthly basis, wholesale prices were unchanged.

“The soft producer prices reading for July points to reduced inflationary pressure for businesses in coming months,” said Ben Ayers, senior economist at Nationwide.

Meanwhile, unemployment claims rose to 209,000 last week, up from a revised 200,000 the week before, though layoffs remain at historically healthy levels. The U.S. unemployment rate stands at a low 4.1%.

The Fed’s Dilemma

The Federal Reserve kept its key interest rate unchanged at about 3.6% at its late July meeting, marking the fifth straight hold. But the vote was 9-3, with three regional Fed presidents dissenting in favor of a rate hike, according to AP News.

“The dissents send a clear message: The Fed is not yet convinced the inflation battle has been won,” said Seema Shah, chief global strategist at Principal Asset Management.

Fed Chair Kevin Warsh acknowledged the challenge: “We have no magic wand. This isn’t something we’re going to be able to carry out in days or weeks.”

Market odds of a September rate hike fell to about 40% after July’s CPI report, according to NPR.

What to Watch

The Fed next votes on rates in mid-September, and the PCE index — the Fed’s preferred inflation gauge — will be released on August 26. Gas prices, which have risen since late July amid a stalemate in the Strait of Hormuz, remain a key wildcard. With consumer sentiment falling to 51 in August — the first decline in three months — the question of whether cooling inflation can coexist with resilient spending remains open.

“We’re clearly not out of the woods,” said Dan North, senior economist at Allianz Trade North America. “However, it makes the Fed’s decision a little bit easier, because now you see that inflation is creeping down.”