MarketWatch

WASHINGTON – Household incomes were flat, consumer spending was tepid and inflation was accelerating in April, putting the Federal Reserve in a pickle about interest rates.

With core inflation rising faster than the Fed wants, pressure is on Chairman Ben Bernanke and the Federal Open Market Committee to raise interest rates for a 17th straight meeting in late June. But with consumers reining in their spending, there’s ample reason for the Fed to hold rates steady.

Government data released Friday show that rising prices in April offset the best growth in wages in nearly two years.

Personal incomes rose 0.5 percent in the month, but consumer prices also rose 0.5 percent, the Commerce Department reported Friday. Real disposable incomes (inflation-adjusted and after-tax) fell 0.1 percent.

Real per-capita incomes fell 0.2 percent, the third decline this year. Consumer spending increased 0.6 percent in nominal terms in April. In real, inflation-adjusted terms, spending increased 0.1 percent, starting the second quarter off on a weak note.

Core inflation – as measured by the personal consumption expenditure price index, excluding food and energy – rose 0.2 percent in April, as expected, after a 0.3 percent gain in March. Core inflation rose 2.1 percent in the past 12 months, the fastest gain since March 2005.

The increase in the core PCE index was 0.2497 percent, which rounded down to 0.2 percent, barely.

“On the surface, the markets were relieved that the core PCE was not up 0.3 percent like the core (consumer price index), but what is 0.001 percent between friends?” said Stu Hoffman, chief economist for PNC.

Treasurys were modestly higher on the day, with the yield on the 10-year note sitting at 5.05 percent. Stocks edged higher.

“The core PCE deflator resting on the precipice between 0.2 percent and 0.3 percent is a nice picture of where the Fed sits today,” said Stephen Stanley, chief economist for RBS Greenwich Capital. “The June rate call is a very tough one. The Fed wants to pause.”

The Fed believes growth will slow, but “will be unwilling to ignore a breach in the Fed’s core inflation comfort zone that shows no sign of reversing any time soon,” Stanley said.

“Together, the PCE core index and the consumption figures frame the (Federal Open Market Committee’s) dilemma for June 29 – the economy does seem to be slowing, probably by more than Fed officials generally expect, but inflation is sticky,” said economists at Goldman Sachs.

Consumer prices including food and energy have risen 3.1 percent in the past year, down from a 3.3 percent pace in March.

Core inflation is now running slightly above the Federal Reserve’s informal “comfort zone” of 1 percent to 2 percent. But the Fed is more concerned about what inflation will do than what it has done.

Fed officials have said they believe core inflation will accelerate temporarily, then recede once the impact of 16 rate hikes takes full effect to slow the economy and temper demand. In a letter released Thursday, Bernanke told a congressman that core inflation remains well contained.

Inflation expectations, however, are rising. The University of Michigan reported Friday that consumers expect an inflation rate of 4 percent in the next year and 3.2 percent for the next five years, significantly higher than expected just a few months ago.

“At least as far as the general public is concerned, long-term inflation expectations are clearly not very well contained at this point,” said Ted Wieseman, an economist for Morgan Stanley.

The Fed meets at the end of June to consider further rate increases. Any further hikes are dependent on the data that come in. The Fed will see May data on payrolls, retail sales and consumer prices, but will not get another reading on the core PCE price index. Currently, a June rate increase is rated as a tossup.

The gains in income and spending in April were close to expectations. According to a survey conducted by MarketWatch, economists expected incomes to rise 0.7 percent and spending to rise 0.6 percent. See Economic Calendar.

In March, incomes rose 0.5 percent, unrevised. Spending increased 0.5 percent in March, revised down from 0.6 percent reported earlier.

With spending rising faster than incomes, the personal-savings rate fell to negative 1.6 percent in April from negative 1.4 percent in March. The savings rate has been negative for 11 consecutive months.

Income from employee compensation increased 0.8 percent in April, the fastest gain since January. Income from wages rose 0.9 percent, matching the best result in nearly two years.

Income from assets increased 0.7 percent.

Tax payments rose 1.6 percent. Disposable incomes rose 0.4 percent.

Real spending on durable goods increased 0.3 percent. Real spending on nondurable goods rose 0.2 percent. Real spending on services increased 0.1 percent.

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