By Matt Grossman

The surge in oil and gasoline prices amid the Iran conflict has darkened the inflation outlook. It is coming at a time when the outlook was already more confused than usual.

The reason: There are two main measures of inflation, and they are telling opposite stories right now. How this gets resolved could be even more important for inflation than what happens in the Middle East.

The 12-month change in the consumer-price index (CPI), the better known of the two, was a fairly tame 2.4% in January, and economists expect it held steady in February. The figure will be released Wednesday.

Meanwhile, the 12-month change in the price index of personal-consumption expenditures (PCE), the Federal Reserve's preferred gauge, was 2.9% in December, and economists expect the same in January when the number arrives Friday, stubbornly above the Fed's 2% target. (PCE data are a couple of weeks late because of the fall government shutdown.)

The two indexes measure inflation differently. The CPI is based on a survey of what households pay for. The PCE is based on everything households consume even if they don't pay for it, such as healthcare.

The current split is unusual, because historically PCE inflation runs a few tenths of a percentage point lower than CPI. If that held today, PCE inflation would now be just above 2%, and the Fed would be declaring mission accomplished. If instead it stays about half a point higher than CPI in January, as consensus forecasts imply, it could be the biggest such gap since the mid-1980s, when inflation was falling rapidly back to baseline after a historic surge.

The gap has elevated a debate that rarely matters outside technical discussions: Which is the true picture of inflation?

Today, it matters crucially for the direction of interest rates. If PCE inflation falls toward the more benign CPI level in coming months, cutting rates would be a straightforward choice for the Fed, especially if the weak February jobs report released Friday previews more labor-market trouble ahead. But if CPI inflation rises toward the PCE's more troubling reading even as unemployment increases, the Fed may be left without good options.

Energy has a bigger weight in the CPI than in PCE, so the Iran conflict would tend to push CPI inflation up toward PCE inflation in coming months. Inflation swaps that reflect professional traders' view of CPI inflation over the next 12 months jumped to about 2.9% last week, versus roughly 2.3% in late February.

Because energy and food prices are so volatile, the Fed and most economists often exclude them, yielding a "core" inflation rate more indicative of underlying trends. This leaves matters just as muddled because the gap between the forecast core rates is even larger.

In December, the median Fed policymaker projected core PCE inflation would fall to 2.5% by the end of this year, thanks to less goods inflation from tariffs and potentially cooler services costs excluding housing, both of which carry more weight in the PCE than the CPI.

But some officials and private economists worry the stubborn recent readings will persist. Last week, Kansas City Fed President Jeffrey Schmid warned services inflation "is also running strong, and faster than what is consistent with us returning to our overall 2% inflation objective."

Although the median projection of officials in December was for one more rate cut this year, Schmid is part of a sizable contingent of hawks who projected that rates should hold steady through all of 2026. The Fed will issue updated projections at its next meeting on March 18.

Because of their differing methodology, CPI and PCE weight spending categories differently. Shelter -- housing, rent and hotels -- makes up a staggering 45% of the core CPI. Because the PCE captures spending on consumers' behalf -- most notably health costs shouldered by employer-paid insurance or the government -- it assigns a larger weight to healthcare, pushing down that of housing.

That largely explains the current split, said Stephen Douglass, chief economist at St. Louis-based NISA Investment Advisors. "In the current episode, housing is disinflating rapidly and medical-services inflation is accelerating," Douglass said. CPI has been pulled down even more by a technical quirk springing from last fall's government shutdown, which many economists think artificially depressed housing prices.

If optimists are right, and tariff effects fade while services inflation also moderates, expect the coming months to ratify CPI's more sanguine picture. Futures markets seem to agree: They see the Fed returning to cutting rates later this year, especially after the weak February jobs data.

But if progress on either of those fronts is elusive, elevated PCE could prove the more accurate picture of inflation.

Phil Suttle, an independent economist, noted that surveys show manufacturers still face rising input prices they might pass along. And excluding housing, services inflation hasn't been declining much either. New tax cuts could strengthen consumer spending this year and firm up inflation as a result, he projected.

"I'm more of the view that we settle closer to 3%," Suttle said.

Write to Matt Grossman at matt.grossman@wsj.com

(END) Dow Jones Newswires

March 09, 2026 05:30 ET (09:30 GMT)

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