The latest inflation figures show the Federal Reserve was already facing an uncomfortable backdrop even before the war involving Iran sent energy prices sharply higher. Core personal consumption expenditures inflation, the Fed’s preferred underlying gauge, remained well above target in February, while growth and income data pointed to an economy that was already losing momentum. Taken together, the numbers suggest the central bank entered the current geopolitical shock with less room to maneuver than many investors may have assumed.
The core PCE price index, which strips out food and energy, rose 3% from a year earlier in February. Headline inflation came in at 2.8%. On a monthly basis, both core and headline prices increased 0.4%. Those results matched expectations, but the broader message was hardly reassuring. Inflation may not have accelerated before the war, yet it also was not back under control in any convincing way.
That matters because this data captures conditions before oil surged above $100 a barrel and gasoline prices jumped by more than $1 a gallon during the conflict. In other words, the economy was already dealing with stubborn inflation before the most visible new source of price pressure even arrived.
Core inflation was still too high
The Federal Reserve targets 2% inflation and places particular emphasis on core PCE because it is viewed as a cleaner measure of longer-term price trends. By that standard, February’s data showed only limited progress. Core inflation did edge down by 0.1 percentage point from January, but at 3% it remained far above the level the central bank wants to see on a sustained basis.
That leaves policymakers in a difficult position. They may prefer to look through temporary energy shocks, especially those tied to war, but they can do that more comfortably when the underlying inflation trend is already close to target. That is not the case here. With core inflation still sticky, any new surge in oil or transport costs risks colliding with a price environment that was already proving slow to normalize.
This is why the February report carries more weight than its timing might suggest. It is dated, but it reveals an economy that had not fully healed before the latest external shock hit.
Consumers kept spending, but income weakened
The report also highlighted a less comfortable picture on the demand side. Consumer spending rose 0.5% in February, showing that households were still spending at a decent pace. But personal income fell 0.1%, missing expectations for a gain and raising concerns about how durable that spending can be if wage and income growth begin to soften.
That imbalance is important. Spending can hold up for a while even when income weakens, but not indefinitely. If households continue facing high prices while their income growth fades, the risk increases that consumers eventually pull back more sharply. For an economy still heavily dependent on household demand, that would create another layer of pressure just as inflation remains too elevated for comfort.
In that sense, the report hinted at an increasingly awkward mix: consumers were still active, but the foundation supporting that activity looked less secure than before.
Growth was weaker than first reported
Any remaining optimism was further undercut by a downward revision to fourth-quarter economic growth. Gross domestic product for the final quarter of 2025 was revised down to a seasonally adjusted annualized rate of just 0.5%, from a prior estimate of 0.7% and well below the initial 1.4% reading. While full-year growth held at 2.1%, the final quarter ended on a noticeably weaker note than previously believed.
The revision was driven mainly by lower investment, another signal that the economy was already cooling before the Iran conflict added a fresh inflation threat. A key demand measure, real final sales to private domestic purchasers, was also revised lower to 1.8%, reinforcing the idea that the private-sector engine was not as strong as earlier numbers had suggested.
That combination of weaker growth and still-elevated core inflation is what has revived talk of stagflation. The economy was not in a full stagflationary state before the war, but the ingredients for a more difficult policy tradeoff were already visible.
The Fed faces a harder policy debate
For the Federal Reserve, the problem is no longer simply whether inflation is easing enough to justify lower rates. It is whether inflation can keep easing at all if oil prices stay elevated while growth and labor market conditions begin to soften. Minutes from the March meeting showed policymakers already worried about both sides of their mandate: inflation was too high, but the economy was not strong enough to ignore.
Markets still expect the Fed to remain on hold for now. Jobless claims rose to 219,000, somewhat above expectations, but not enough to signal a labor market breakdown. That leaves policymakers waiting for clearer evidence, especially as they assess whether the recent ceasefire changes the inflation outlook or merely delays another wave of volatility.
The next inflation test will come with the consumer price index report for March, where headline inflation is expected to jump sharply. If that happens, the Fed will be forced to confront an uncomfortable truth: inflation was already sticky before the energy shock, and now the economy may have to absorb both at once.
