By Lucia Mutikani
WASHINGTON (Reuters) - U.S. inflation was much weaker than initially thought in the first quarter amid a sharp slowdown in domestic demand, which could cast doubts on the Federal Reserve's view that the benign price pressures were largely because of temporary factors.
The weak inflation pulse reported by the Commerce Department on Thursday could also pile pressure on the U.S. central bank to cut interest rates, especially as the economy appeared to slow in the second quarter. Fed Chairman Jerome Powell said recently he believed the soft inflation "may wind up being transient."
The personal consumption expenditures (PCE) price index excluding the volatile food and energy components increased at a 1.0% rate last quarter, the government said. The so-called core PCE price index, which is the Fed's preferred inflation measure, was previously reported to have risen at a 1.3% pace.
The increase last quarter was the smallest in four years and pushed inflation further below the Fed's 2% target. Inflation has been running below its target this year and President Donald Trump has urged the Fed to cut rates.
"The low inflation readings are likely to be persistent," said Sung Won Sohn, an economics professor at Loyola Marymount University in Los Angeles. "With both inflation and economic growth going in the wrong direction, the Fed is likely to cut rates later this year."
The Fed early this month kept rates unchanged and signaled little inclination to adjust monetary policy anytime soon. Inflation has been restrained in part by weaker prices for portfolio management services, apparel, and airfares.
Economists said the sharp downward revision to the first-quarter inflation rate raised the risk of a lower core PCE price index number in April.
With healthcare costs rising at both the producer and consumer levels in April, economists had expected the core PCE price index reading to remain unchanged at 1.6% year-on-year in April.
The government will publish the April core PCE price index data on Friday. Inflation hit the Fed's 2% target in March last year for the first time since April 2012.
"This raises the chances that tomorrow's core PCE inflation rate prints at 1.5% on a year-over-year basis, which would potentially give the Fed more ammunition to worry about a low inflation rate," said John Ryding, chief economist at RDQ Economics in New York.
The dollar was little changed against a basket of currencies, while U.S. Treasury prices rose. Stocks on Wall Street were trading higher.
The government also reported on Thursday that gross domestic product increased at a 3.1% annualized rate in the first quarter, pared from the 3.2% pace it estimated last month. The economy grew at a 2.2% pace in the October-December period.
The economy will mark 10 years of expansion in July, the longest on record. Growth last quarter was, however, flattered by the volatile export, inventory and defense components.
Excluding trade, inventories and government spending, the economy grew at a 1.3% rate, the slowest since the second quarter of 2013. This measure of domestic demand increased at a 2.6% pace in the fourth quarter.
When measured from the income side, the economy grew at a rate of 1.4% in the first quarter. Gross domestic income (GDI), increased at a 0.5% pace in the fourth quarter.
The average of GDP and GDI, also referred to as gross domestic output and considered a better measure of economic activity, increased at a 2.2% rate in the January-March period, up from a 1.3% growth pace in the fourth quarter.
The inventory-and-export-driven growth spurt appears to have fizzled early in the second quarter. The slowdown largely reflects the fading stimulus from the Trump administration's hefty tax cuts and spending increases last year. A trade war between the United States and China is also hurting the economy.
In another report on Thursday, the Commerce Department said exports fell 4.2% in April. The report added to weak April data on industrial production, orders for long-lasting manufactured goods, retail and home sales.
The growth drag from inventories is, however, likely to be small. The government reported that wholesale inventories increased 0.7% last month, while stocks at retailers rose 0.5%.
The Atlanta Fed is forecasting GDP rising at a 1.3% rate in the second quarter.
"A recession is not in our baseline, but we note the dangers from the recession bias leading to self-fulfilling prophecies," said Lydia Boussour, a senior U.S. economist at Oxford Economics in New York.
The economy is seen supported by a strong labor market, which is boasting the lowest unemployment rate in nearly 50 years. In a separate report on Thursday, the Labor Department said initial claims for state unemployment benefits rose 3,000 to a seasonally adjusted 215,000 for the week ended May 25.
(Reporting by Lucia Mutikani; Editing by Andrea Ricci)