Consumers were a bit less optimistic in August than one month or one year ago, although consumer confidence remains at a reasonably high level. Less favorable personal financial prospects were largely offset by a slight improvement in the outlook for the overall economy. Most of the weakness in personal finances was among younger households who cited higher expenses than anticipated as well as slightly smaller expected income gains. Importantly, long term inflation expectations fell to the lowest level ever recorded, with near term inflation expectations anchored to that same low level. Low interest rates have increasingly become the sole driver of large discretionary expenditures. Strength in personal finances and low interest rates will maintain the growth in real consumption at 2.6% through mid 2017.

Mixed Changes in Personal Finances
Among all households, 44% reported that their financial situation had recently improved, unchanged from one month or one year ago. One-third of all households reported recent income gains in August, the same as in July. Financial prospects for the year ahead declined in August, as just 29% expected their finances to improve, down from 36% in July and the lowest level since late 2014. Most all of the decline was among those under age 35.

Favorable Buying Attitudes
The source of favorable buying plans has shifted from attractive pricing to low interest rates. Home buying has become particularly dependent on low mortgage rates, with net references to low rates mentioned by 53%—this figure has been exceeded in only one month in the past ten years. In contrast, low housing prices were cited by just 26%, for the fourth time in the last 5 months, and the lowest figure in ten years.

The Consumer Sentiment Index was 89.8 in the August 2016 survey, barely below July’s 90.0 and slightly below last August’s 91.9. The Sentiment Index remained largely unchanged in August from one month ago due to offsetting shifts: the Expectations Index rose to 78.7 from 77.8 last month, while the Current Conditions Index declined to 107.0 in August from 109.0 in July.

Consumers have become increasingly dependent on ultra low inflation and interest rates. While wage gains have recently improved, it is still low inflation that has been a key ingredient in preventing declines in the living standards. Consumers do not anticipate an increase in inflation anytime over the next five years, and have increasingly discounted any significant increase in interest rates during the year ahead. Small increases in inflation or interest rates would not be surprising to consumers, but the expectation of policies aimed toward cumulative increases in inflation or interest rates could cause a more substantial and negative reaction.