American households’ spending cooled significantly in February after having the largest one-month gain in nearly two years in January, offering possible signs of a slowing economy as the Federal Reserve continues to pounce on inflation through interest rate hikes.

Consumer spending increased 0.2% in February, from January’s revised 2% increase, figures from the U.S. Bureau of Economic Analysis showed on Friday. But when adjusting for rising prices, spending decreased 0.1% in February from the prior month’s 1.5% increase after revisions. 

February’s data doesn’t include any impact on consumer spending from the banking industry failures, which emerged in March. 

The latest data suggests a downturn in consumer spending is finally beginning to bear fruit, something the Fed has desperately fought for in its bid to tame inflation, which appears to have reversed course and is decelerating again. As the Fed balances its next move on May 3, it will closely watch inflation, the labor market, and consumer spending, especially after the recent bank fallouts that could calm lending, slowing down the economy without the Fed intervening further. 

“The economy has been resilient,” said Sam Bullard, Managing Director and Senior Economist at Wells Fargo. “But it is showing signs of slowing and we anticipate that slowing to continue.” 

The latest data showed that inflation is cooling after unexpectedly heating up in January.

The Personal Consumption Expenditures Index, the Fed’s preferred measure of inflation, increased 0.3% in February, down from a 0.6% increase in January. Excluding food and energy, the PCE price index also rose 0.3%, a lower increase from the previous months’ data. 

But while the inflation numbers showed signs of slowing down, the year-over-year change remains far above the Fed’s preferred measure of reigning in inflation. 

The PCE price index slowed to 5% on an annual basis in February, down from 5.3% in January. It was the lowest reading for the measure since September 2021 but still double the Fed’s goal of 2% inflation. 

To Bob Stein, Deputy Chief Economist at First Trust Advisors, the market has been "overly optimistic" about the inflation data from the report. 

"The market had an overly benign interpretation of the inflation side of today's report," he said. "And that it really doesn't reduce the changes that the Fed is going to lift rates at the next meeting."

While Friday's report yields mostly promising results, the Fed raised interest rates by 0.25 basis points on March 22, and another hike is not out of the question after recent banking turmoil. 

Instead, the Fed will evaluate several sectors of the economy, like hiring, unemployment, and housing, in addition to the potential impact of the recent bank fallouts on whether to raise interest rates during its May 3 meeting.

In February, employers added 311,000 jobs, and the unemployment rate remained nearly untouched despite being near historic lows after a shockwave of new hires in January. Initial jobless claims, or layoffs, are hovering near historically low levels but reached a high point, according to the latest data, signaling potentially more layoffs. And home sales rose in February from the prior month for the first time in a year after the housing market appeared frozen because of high-interest rates.

While the Fed's road ahead appears bumpy, the report still offers favorable indications that the economy is slowing down.

Even one of the most resilient sectors of the economy – spending on services, such as eating at restaurants – showed a modest decline in February after adjusting for inflation, possibly indicating consumers are feeling the effects of rising interest rates.

Zack Shaw, 27, a server at a local restaurant in Queens, New York, cut back on most of his expenses after the pandemic, but as the economy restarted, he dined at restaurants more and more. Recently, he decided it was time to put off going out to eat as often as he's been going. 

"I felt like at one point the only money I spent was on going out to eat," Shaw said. "But I've started eating out less. It's just too expensive."  

But as consumers spent less in February, incomes grew more modestly than the previous month.

Personal income grew by 0.3% in February, but slower than the previous month's 0.6% increase, as wages and salaries rose in the private sector, services-producing industries, and government jobs. 

But as the economy moves forward, Bullard, the Wells Fargo economist, said this report wouldn't change many economists' expectations of where the economy is headed or what the Fed might do in May. 

And while he said the report is primarily encouraging, he said the recent bank failures and upcoming economic indicators would weigh on whether or not the Fed's decision to raise interest rates in May. 

"This is a train in motion that has to continue to move forward," Bullard said.