Americans, who have been struggling with rapidly rising prices for three years, just received more positive news on the inflation front.
The Consumer Price Index (CPI), which measures the average change in prices for a commonly purchased basket of goods and services, dropped 0.1% from May. This decrease helped to slow the annual inflation rate to 3% from 3.3% in May, according to the latest report from the Bureau of Labor Statistics (BLS).
Lower gas prices and a decrease in new and used car prices contributed to the first month-on-month decline since May 2020, BLS data showed. Annually, consumer prices are increasing at their slowest pace since June 2023, matching the lowest annual rate since early 2021.
The better-than-expected inflation report has bolstered hopes that the Federal Reserve might cut interest rates sooner, making borrowing money less expensive. Interest rates have remained at a 23-year high as a part of the central bank’s efforts to combat inflation.
With another favorable CPI report, there is potential for the Federal Reserve to cut interest rates as early as September, and possibly again in December, assuming that inflation data remains favorable, according to Skyler Weinand, chief investment officer at Regan Capital.
Economists had anticipated a 0.1% monthly increase and an annual gain of 3.1%, according to FactSet consensus estimates.
Excluding energy and food prices, the closely watched “core” index of underlying inflation also slowed more than expected. The core CPI rose 0.1% from May — its slowest pace since August 2021 — lowering the annual core inflation rate to 3.3% from 3.4%, marking a new three-year low.
US stocks initially rose on the news but quickly retreated and finished lower. The Dow fell 90 points in morning trading. The S&P 500 turned negative, and the tech-heavy Nasdaq was flat. US Treasury yields dropped, which could benefit consumers as loans like mortgages are linked to the 10-year yield.
The likelihood of a Fed rate cut is growing, but so are the risks. Wall Street is increasingly confident that cooling inflation will allow the Federal Reserve to cut interest rates in the coming months.
Investors are now pricing in an 89% chance of at least one rate cut by the September 17-18 Fed meeting, according to CME Group’s FedWatch Tool. This is up from 73% on Wednesday and around 50% a week ago.
The US labor market has also cooled, with unemployment rising for three consecutive months to 4.1% in June.
“It would be reasonable to cut rates in July; however, the Fed is bound by its forward guidance and backward-looking approach and won’t move until September,” said Tuan Nguyen, an economist at RSM US, in an interview.
While falling gas prices played a significant role in reducing inflation, progress was also seen in shelter costs, a critical area. The shelter index rose just 0.2% during June, the slowest monthly increase in three years. Annually, shelter-related price hikes rose 5.2%, the coolest reading in two years but still above overall inflation.
Shelter inflation remains a major hurdle to slowing CPI (the category accounts for about one-third of the overall CPI). Economists have anticipated a slowdown as market-rate rents have slowed, but how they’re recorded in the CPI involves a lag, and estimating housing cost inflation is a complex process.
Lower hotel and motel prices contributed to the overall cooling of the shelter index, while rent and owners’ equivalent rents both slowed on a monthly and annual basis.
“Today, the shelter component has finally aligned with our predictions from the past year,” said Nguyen. “And that moderation should continue in the second half of the year.”
Major retailers have announced price cuts in recent months, a trend that may continue as consumers become more restrained.
“I think consumers feel and act increasingly strained, making it harder for businesses to pass on prices as we move through the year,” said Wells Fargo’s House. “Discounting pressures other retailers to compete more on price given that consumers are more squeezed at this stage of the cycle.”
Food prices rose slightly last month, increasing by 0.2% overall. Grocery prices increased by 0.1%.
Though prices may not be rising as quickly, the overall CPI remains about 20% higher than it was in February 2020, which could have lasting effects on consumer behavior, said Michael Weber from the University of Chicago Booth School of Business.
“For many consumers, the price tags compared to two or three years ago will be permanently higher, given the cumulative inflation,” Weber said.
The Fed monitors gauges of inflation expectations closely as these can become self-fulfilling prophecies. If people expect higher prices in the future, they might spend more now or demand higher wages, leading businesses to raise prices.
While near-term inflation expectations have lessened, the impact of high prices is evident on a larger scale, including the US presidential election.
“People compare current prices to two years ago, not the rate of change. This affects the public’s perception of the economy and has impacted Biden’s image regarding his handling of the economy,” said Bernard Yaros, lead US economist at Oxford Economics.