Inflation data released Wednesday showed a marked cooling and provided some of the most hopeful news since the Federal Reserve began trying to tame rapid price increases 16 months ago.
The consumer price index climbed 3 percent in the year to June, less than the 4 percent increase for the year through May and just a third of the peak of around 9 percent last summer.
This general metric captures large declines in gas prices and a few other products that can prove volatile, which is why policymakers are closely watching another measure: the change in prices after stripping out food and fuel costs. That measure, known as the core index, offered news that was even better than economists had expected, sending stocks higher as investors bet the news would allow the Fed to raise interest rates by less than they otherwise might have.
The core index rose 4.8 per cent compared to the previous year, down from 5.3 per cent in the year to May. Economists had predicted an increase of 5 percent. And on a monthly basis, the core index climbed at its slowest pace since August 2021.
“This is very promising news,” said Laura Rosner-Warburton, senior economist and founder of MacroPolicy Perspectives. “The pieces of the puzzle are starting to come together. But it’s only one report, and the Fed has been burned by inflation before.”
Slower inflation is undoubtedly good news, because it allows consumers’ paychecks to stretch longer and inflicts less pain at the gas pump and in the grocery aisle. But Federal Reserve officials are still trying to assess whether the cooldown is likely to be quick and complete. They don’t want to let price increases hang at slightly elevated levels for too long, because if they do, consumers and businesses might adjust their behavior in ways that make faster inflation a permanent feature of the economy.
Given that, they may be cautious in interpreting the news. Officials have signaled in recent weeks that they are likely to raise interest rates at the meeting on 25-26. July.
Rosner-Warburton said she thought a move in July was still likely, but that the fresh inflation data could set the stage for “a longer pause” afterwards. She added that a cooling in car prices and slower rent increases should keep the moderation in inflation going, and she predicted that the Fed would not raise interest rates again this year after the July change.
The fall in inflation in June came as a few key products and services showed sharp price declines. Flight prices fell 8.1 percent compared to the previous month, and used cars and trucks fell 0.5 percent. New vehicle prices were flat compared to May.
Not all of these changes will necessarily last: Airfare, for example, is not expected to continue to fall as sharply as it did in this report. But for the Fed, there were other encouraging signs that the cooling is broad enough to prove sustainable.
Firstly, housing costs measured by the consumer price index – which depend on rental prices – are falling sharply. It is expected to continue in the coming months. An index tracking rents for primary residences eased to a change of 0.46 percent in June, the weakest increase since March 2022.
Car prices are also cooling. After years in which semiconductor shortages and other parts problems limited supply, making it difficult to meet booming demand, rebates are making a comeback on car dealers’ lots. Inventory is on the rise, and consumers have a less voracious appetite for new cars in particular.
“It’s different from the last couple of years, and even different from the fall,” said Beth Weaver, who runs a Buick GMC dealership in Erie, Pa. “Interest rates have certainly weighed on demand.”
And more broadly, price increases for a basket of services excluding energy, food and housing costs — a metric the Fed watches very closely — continued to ease in June.
But despite all the recent progress, inflation remains above the increase that was normal before the 2020 pandemic. And the economy is still gaining momentum, with strong job and wage growth, which could give companies the opportunity to continue raising prices. That’s why Fed officials are hesitant to say they’ve won the battle against inflation.
“It would be a mistake” to “declare victory” too soon, Loretta Mester, the president of the Federal Reserve Bank of Cleveland, said on a call with reporters this week.
The Fed officially targets 2 percent inflation on average over time, although it defines this target using a separate inflation measure, the personal consumption expenditure index. This gauge is also declining noticeably, and the June reading is scheduled to be released on July 28.
Although central bank governors are likely to interpret the slowdown cautiously — acknowledging that price increases have slowed and then accelerated again before — many commentators welcomed the fresh data point as the latest sign that the economy may be able to slow down gently.
Fed officials have tried to engineer a “soft landing” in which inflation slows gradually and without requiring a big jump in unemployment. Interest rate increases act, among other things, by slowing down the labor market and cooling wage increases, so that the Fed’s fight against inflation and the strength of the labor market are closely linked.
“The sustained decline in inflation is encouraging news for the US labor market outlook,” Julia Pollak, chief economist at ZipRecruiter, wrote in response to the recent release. “It increases the likelihood that the Fed will be able to pause rate hikes after a recent increase in July, and gradually lower rates through 2024.”