US consumer spending, core PCE inflation firmer before Iran war

* Consumer spending increases 0.4% in January

* Personal Consumption Expenditures price index excluding food and energy rises 0.4%; up 3.1% year-on-year

* Core capital goods orders unchanged; shipments fall 0.1%

By Lucia Mutikani

WASHINGTON, March 13 (Reuters) - U.S. consumer spending rose solidly in January and underlying inflation maintained a strong pace of increase, which together with the dragging war in the Middle East strengthened economists' views that the Federal Reserve would not resume cutting interest rates before September.

Despite the slightly larger-than-expected increase in spending, other data from the Commerce Department on Friday were downbeat. Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, were unchanged in January and economic growth slowed at a sharper pace than initially thought in the fourth quarter.

Following in the wake of unexpected job losses in February, the reports put stagflation on the radar, complicating the U.S. central bank's job.

"We now see a steep rise in inflation and weaker economic activity in the second quarter due to the spike in gasoline and energy prices, weaker exports as the rest of the world reels from the disruptions, and an erosion in business confidence," said Kathy Bostjancic, chief economist at Nationwide.

Consumer spending, which accounts for more than two-thirds of economic activity, rose 0.4% in January after increasing by the same margin in December, the Commerce Department's Bureau of Economic Analysis said. Economists polled by Reuters had forecast consumer spending advancing 0.3%.

The BEA is still catching up on data releases following delays caused by last year's government shutdown. The longest-ever shutdown, which weighed on government spending, combined with a moderation in consumer spending late last year and a slower pace of business investment to hold back gross domestic product growth to an annualized 0.7% rate in the fourth quarter.

GDP growth was previously estimated to have increased at a 1.4% pace. The economy grew at a 4.4% rate in the third quarter.

Consumption could take a hit from the U.S.-Israeli war against Iran, which has boosted oil prices. Retail gasoline prices have soared more than 20% to $3.60 per gallon since the conflict started, data from motorist advocacy group AAA showed.

The war is also causing volatility on the stock market, with economists warning of wealth reduction among higher-income households that could force some to cut back on spending. High-income households are the main drivers of consumer spending and the overall economy. Lower-income households have already scaled back as tariffs on imports raised prices for goods.

U.S. stocks opened mixed. The dollar rose against a basket of currencies. U.S. Treasury yields fell.

SLOWER ECONOMIC GROWTH IS EXPECTED

Economists expected the drag on the economy would be felt in the second quarter. Inflation was already elevated before the war. The Personal Consumption Expenditures price index increased 0.3% in January after rising 0.4% in December, the BEA said.

In the 12 months through January, PCE inflation advanced 2.8% after rising 2.9% in December. Excluding the volatile food and energy components, the PCE price index rose 0.4% after a similar gain in December and in line with economists' expectations. Core PCE inflation climbed 3.1% year-on-year, the largest gain since March 2024, after rising 3.0% in December.

The Fed tracks the PCE inflation measures for its 2% target. The central bank is expected to keep its benchmark overnight interest rate in the 3.50%-3.75% range next Wednesday. Economists see the window for rate cuts closing, with financial markets anticipating a single reduction this year in September.

A separate report from the Commerce Department's Census Bureau showed core capital goods orders were unchanged in January after increasing 0.8% in December. Economists had forecast orders for these rising 0.5%. Shipments of core capital goods fell 0.1% after increasing 1.0% in December.

Business spending on equipment could pick up amid increased spending on artificial intelligence and the construction of data centers. The government reported on Thursday that imports of capital goods rose to a record high, driven by computers and telecommunications equipment. Business spending on AI and data center construction is helping to support some segments of manufacturing, which has been constrained by import tariffs.

Orders for durable goods, items ranging from toasters to aircraft meant to last three years or more, were also unchanged in January after falling 0.9% in December.

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(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci )