The news: Consumer spending rose more than expected in September as shoppers coped with higher costs for gas and everyday goods.

• Retail sales rose 0.8% month over month (MoM), double the 0.4% increase economists polled by The Wall Street Journal were expecting.
• But sales excluding gas and motor vehicles increased just 0.2% MoM, showing that rising energy costs were the driving force of spending growth over the month.

September sales rose 6.3% YoY, comfortably outpacing the 3.7% inflation rate. That suggests consumers are spending more in real terms, reflecting some flexibility in their ability to absorb higher prices as well as a willingness to spend under the right circumstances.

The big picture: September’s solid retail performance doesn’t adequately reflect the pressures that many consumers are feeling as they add rising energy costs to already stretched budgets.

Persistent inflation is reshaping consumers’ view of the economy and their finances.

• Inflation has been above the Fed’s 2% target for 66 straight months, the third-longest stretch since 1948, according to a CNBC analysis. This prolonged period of elevated inflation is deepening households’ pessimism about their current and future financial situations.
• It also raises the risk that businesses and consumers will expect persistently higher prices—particularly as higher diesel costs filter through the economy—and adjust their behavior accordingly, potentially perpetuating the inflationary cycle.

Consumers are changing their purchase patterns to manage rising prices.

• Middle- and high-income households are shopping more often at value-oriented retailers such as Walmart, Costco, and Dollar General, pointing to a broad-based desire among consumers to find savings where they can.
• Only 31% of consumers plan to spend as usual on items facing large price increases in the year ahead, while 54% plan to cut back on those categories and 16% will stop altogether, per the University of Michigan. That trend spans income levels.

Lower income households are under sustained pressure.

• 71% of lower-income adults say they had difficulty affording at least one basic necessity—such as medical care, daily transportation costs, rent or mortgage payments, or food—in the past year, according to Pew Research Center.
• These consumers are also facing higher levels of inflation than the rest of the population, with prices for the cohort up 36% since January 2018, compared with the national average of 34%, per Numerator.
• Stricter SNAP rules are worsening the blow, causing participation in the program to fall to the lowest levels since 2009 even as food prices rise, according to Department of Agriculture data.

Implications for retailers: All of these trends set the stage for a challenged holiday season. We expect retail sales growth during the period to lag the annual average as shoppers concentrate spending on major promotional periods and adjust their budgets to account for higher everyday expenses.

Retailers face a harder battle to win spending as consumers grow more selective. Value-focused messaging will be important to attract budget-conscious shoppers, but companies will need more than just promotions to get customers’ attention. Engaging in-store experiences, new and exciting products, and building emotional connections will be key to maximizing shopper engagement and driving sales.