In a dramatic turn of events, U.S. consumer prices fell for the first time in four years this June, thanks to cheaper gasoline and moderating rents. This significant drop signals a return to disinflation and nudges the Federal Reserve closer to slashing interest rates as early as September.
Thursday’s report from the Labor Department showed a second month of benign consumer price readings, reinforcing the belief among Federal Reserve officials that inflation is finally cooling after a steep rise earlier this year. The data also revealed the smallest increase in underlying inflation since August 2021, boosting financial markets’ optimism for the Fed’s impending rate cuts.
“Barring any unexpected price spikes in July, the Fed has the green light to reduce rates in September,” stated Brian Bethune, an economics professor at Boston College. “This guidance will be solidified at the July meeting.”
The consumer price index (CPI) dipped by 0.1% last month, marking the first decline since May 2020, following a stagnant May. The drop was primarily driven by a 3.8% reduction in gasoline prices, which had already seen a 3.6% decline in May. Shelter costs, encompassing rents, saw a modest increase of 0.2%, down from a 0.4% rise in May.
Food prices inched up by 0.2%, after a 0.1% increase in May. Grocery store prices saw a slight rise of 0.1%, with higher costs for dairy products, meat, fish, and eggs balanced by lower prices for fruits, vegetables, and cereals.
Over the past year, the CPI rose by 3.0%, the smallest annual increase since June 2023, following a 3.3% rise in May. Economists surveyed by Reuters had predicted a 0.1% monthly increase and a 3.1% year-on-year rise.
This broad moderation in inflation aligns with reports from retailers indicating that consumers are pushing back against higher prices. Retail giants like Target and Walmart have been slashing prices on various goods, providing a rare bit of good news for President Joe Biden, who has been grappling with declining popularity due to high living costs.
The annual increase in consumer prices has significantly slowed from its peak of 9.1% in June 2022. This CPI report followed news that the unemployment rate rose to a 2.5-year high of 4.1% in June from 4.0% in May.
Economic growth has also decelerated due to the central bank’s substantial rate hikes in 2022 and 2023, with second-quarter gross domestic product (GDP) expected to grow at an annualized rate of around 1.8%, which policymakers consider to be the non-inflationary growth pace.
Federal Reserve Chair Jerome Powell acknowledged the improving trend in price pressures but indicated to lawmakers that it is too early to declare victory over inflation, noting that “more good data” would strengthen the case for rate cuts. Powell also highlighted potential risks to the labor market, stating, “We have seen considerable softening.”
Economists interpreted this as a signal that the Fed might shift its focus to the labor market and consider lowering borrowing costs even if inflation remains above its 2% target. Financial markets now estimate an 85% chance of a rate cut at the Fed’s September meeting, up from 70% before the report. Two rate cuts are expected this year.
“Today’s report, and the Fed’s subtle shift to a more balanced focus on slowing employment growth, firmly put a September rate cut in sight,” said Richard de Chazal, macro analyst at William Blair.
In a separate report on Thursday, the Labor Department revealed that initial claims for state unemployment benefits fell by 17,000 to a seasonally adjusted 222,000 for the week ending July 6, the lowest level since late May.
The claims data included the Independence Day holiday, which tends to create volatility. Additionally, automakers typically shut down assembly plants starting the week of July 4 to retool for new models, adding further volatility and complicating labor market readings.
The number of people receiving benefits after an initial week of aid, a proxy for hiring, slipped by 4,000 to a seasonally adjusted 1.852 million during the week ending June 29.
On Wall Street, stocks showed mixed results, U.S. Treasury yields fell, and the dollar slipped against a basket of currencies.
The central bank has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range since last July, after hiking its policy rate by 525 basis points since 2022.
Excluding volatile food and energy components, the core CPI rose by 0.1% in June, the smallest increase since August 2021, following a 0.2% rise in May. The core CPI was restrained by a moderation in rents, which increased by 0.3%, the smallest gain since August 2021.
Consumers also saw relief in healthcare costs, which rose by 0.2% after a 0.5% increase in May. Prices for airline fares, used cars and trucks, new motor vehicles, and communication services all declined. However, motor vehicle insurance prices rebounded by 0.9% after falling by 0.1% in May.
Costs for household furnishings and operations, personal care, education, recreation, and apparel all increased.
Over the past year, the core CPI increased by 3.3%, the smallest year-on-year advance since April 2021, following a 3.4% rise in May. Over the past three months, the core CPI increased at an annualized rate of 2.1%, the smallest rise since March 2021, down from the 3.3% pace in May.
The moderation in CPI data is expected to be reflected in the Personal Consumption Expenditures (PCE) price indexes, the inflation measures the central bank tracks for monetary policy.
“There is light at the end of the tunnel after the central bank’s long battle with inflation, and interest rate cuts, lots of them, are on the way,” said Christopher Rupkey, chief economist at FWDBONDS.
