The PCE-CPI Gap and the Outlook for Further Fed Tightening

Kelly expects the unusual PCE-CPI inflation gap to close via falling PCE, supporting only one more Fed hike, not three.

• Unusual inflation gap: Core PCE inflation ran 3.2% year-over-year in July 2026 versus core CPI at 2.4%, an 0.88-point gap, the widest positive spread in over 40 years.
• Four drivers identified: BEA's methodology splits the CPI-PCE gap into formula, weight, scope, and 'other' effects; the formula effect (fixed vs chain-weighted baskets) has shrunk since annual CPI basket updates began in 2023.

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