With the new year came the return of a bad combination: inflation eating away at Americans' pay gains.

Why it matters: In the second half of last year, cooler inflation meant strong wages translated into pay gains in real terms, helping support the robust consumer spending that's kept the economy humming. But in January, a pickup in prices crushed income gains.

Driving the news: The Personal Consumption Expenditures Price Index, the Federal Reserve's preferred inflation measure, rose 0.3% in January, or 0.4% when food and energy are excluded.

• That core inflation reading was the highest in a year on a month-to-month basis, affirming earlier data pointing to an uptick in January inflation.
• However, year-over-year inflation continued its downward glide. The 2.4% headline PCE inflation and 2.8% core were both the lowest since February 2021.

By the numbers: Overall personal income rose 1% in January — at first glance, a huge gain, driven by the Social Security cost of living adjustment and higher dividends on stock portfolios.

• But tease it apart, and Americans' income picture was gloomier. Disposable personal income — income after taxes — rose a more modest 0.3%.
• And once you account for inflation, income didn't rise at all: It was flat, compared to a 0.2% gain in December.
• It was "a large nominal income surge entirely offset by taxes and inflation," as EY-Parthenon chief economist Gregory Daco put it in a note.

What to watch: Sluggish real income growth could dampen future consumer spending and keep Americans' economic optimism low.

• Consumers are likely to rein in "spending this year after drawing down the pandemic-related savings, driving the savings rate well below its pre-pandemic levels, and increasing their reliance on credit," Kathy Bostjancic, chief economist at Nationwide, wrote this morning.

Higher January inflation was already baked into the cake. The absence of worse-than-expected news on the inflation front triggered a relief rally on Wall Street this morning.

• The open question now is whether the January inflation surge is truly a one-time setback or a warning sign that inflation won't go away quite as painlessly as it seemed last year.

State of play: The consensus view right now tilts toward the bump-in-the-road narrative.

• "Hot January inflation data adds to uncertainty and pushes back rate cut expectations," said David Alcaly, lead macroeconomic strategist at Lazard Asset Management.
• "But odds remain that this is a speed bump and that, while there may be additional short-term swings in market narrative, it will ultimately matter more how deep any rate cutting cycle goes over time than when it begins," he wrote in a note.

Between the lines: The fact that interest rates have been as high as they have been — nearly 5.5% — since July without generating more of a slowdown in spending and incomes gives the Fed some leeway to keep rates high without worrying too much that they'll crater the economy.

• It's easy to keep rates high in hopes of fully quashing inflation when recession warnings — for the moment, at least — are few and far between.
• Just this morning, for example, the Labor Department said that unemployment insurance claims ticked up slightly to 215,000 last week — not remotely the kinds of numbers usually seen when a recession looms.