Milder Inflation Opens Door Wider to September Rate Cut
U.S. inflation eased substantially in June, extending a recent slowdown in price increases that clears a path for the Federal Reserve to cut interest rates by the end of the summer.
The consumer-price index, a measure of goods and services costs across the economy, fell slightly from May, dropping the year-over-year inflation rate to 3%, which was the lowest since June 2023.
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Core prices, which exclude volatile food and energy items and are seen as a better gauge of underlying inflation, rose 0.1% since May. That was the mildest increase since January 2021, when large swaths of the economy were still frozen by the pandemic.
Altogether, the report showed prices cooled broadly in the second quarter and were below economists’ expectations—the reverse of what happened in the first three months of the year, when inflation was surprisingly brisk.
“We’ve definitely seen a pretty sharp slowing,” said Kevin Cummins, chief U.S. economist at NatWest Markets. “This is certainly a confidence booster for the Fed.”
The report keeps the door wide open to a September interest-rate cut. Earlier this week, Fed Chair Jerome Powell laid the groundwork to cut by suggesting the labor market is slowing in a way that has diminished a major source of inflation and risks further weakness that wouldn’t be desirable.
Investors don’t expect the Fed to lower interest rates at its next meeting, July 30-31. Officials haven’t publicly attempted to rally a consensus around such a move and, outside of extraordinary cases, resist taking markets by surprise.
A bigger question for that meeting is the degree to which officials lay the groundwork for a September cut. San Francisco Fed President Mary Daly told reporters Thursday she expected interest-rate cuts could be warranted before too long but refrained from endorsing a move at the July meeting.
The decision over whether to cut rates at one meeting versus the next wasn’t particularly meaningful for the broader economy as long as “people understand where we’re likely to be headed,” Daly said. Placing more emphasis on maintaining a strong labor market, as Powell did this week, “is a fairly big communications signal” about where the Fed is moving, she said.
After the report was released, investors dialed up bets that the Fed would cut rates twice this year, and the odds of a third cut climbed, implying the central bank could lower rates at its last three meetings of the year, in September, November and December.
What is down, what is up
Thursday’s report could be especially comforting to policymakers because it showed housing costs are slowing after a mammoth run-up following the pandemic.
Housing inflation, which reflects the cost of renting and accounts for about one-third of the CPI, has kept overall prices high.
Economists and Fed officials have long anticipated that this inflation would ease because rents for new housing units have been cooling for 1½ years. But the figure often trails market conditions by many months. The latest report seemed to provide welcome confirmation that official inflation gauges are now capturing those developments.
Price increases were generally subdued across a range of categories. The costs of air travel and staying at a hotel fell particularly sharply from the previous month.
U.S. airlines have been cutting ticket prices—a reversal from a year ago, when airlines strained to expand flying quickly enough to meet demand. Then, “everyone was traveling, and it didn’t really matter what it cost,” Delta Air Lines Chief Executive Ed Bastian said in an interview Wednesday.
This summer, airlines have added more than enough flying to accommodate the record numbers of passengers at U.S. airports, and fares have eased. The discounting contributed to a sharply lower second-quarter profit when Delta reported results Thursday.
While inflation has cooled notably over the past two years, many Americans have taken little comfort from milder 12-month inflation readings because the run-up in the price of everything from cars to restaurant meals to housing since 2021 has been abnormally large.
Executives at PepsiCo, which also reported quarterly results Thursday, indicated that inflation-weary shoppers are cutting back.
For the past few years, even as prices soared, many consumers kept buying affordable treats like Doritos and Lay’s in lieu of bigger-ticket splurges such as restaurants, concerts or travel. But now, they are limiting their spending in all areas, said Jamie Caulfield, chief financial officer.
“There is a cohort of consumers that have become more price conscious,” Caulfield said. “They’re looking for more deals to get more for their money.”
Car insurance, meanwhile, remained a hot spot for inflation, reflecting in part the lingering impact of a previous increase in car prices. Those have come down more recently, including in June.
‘Our work is far from done’
Declines in large tech stocks pulled the S&P 500 lower on Thursday. But the Russell 2000, an index of small and midsize companies, posted a big gain, reflecting enthusiasm about the inflation report.
A move by the Fed to start cutting interest rates could be especially helpful to smaller businesses because they tend to have more floating-rate debt than larger companies.
U.S. Treasurys also staged a robust rally, driving their yields lower. The yield on the benchmark 10-year Treasury note settled at 4.192%, down from 4.280% Wednesday. Movements in yields tend to broadly reflect investors’ expectations for short-term rates set by the Fed.
Heading into Thursday, there had been signs the economy has cooled—not enough to stir fears of a recession but sufficient to spur a change of tone from the Fed. Officials are trying to balance the risk of cutting rates too soon and allowing inflation to persist with the risk of waiting too long and causing unnecessary damage to the job market.
The central bank increased its benchmark rate most recently in July 2023 to around 5.3%, the highest level since 2001, to combat inflation that hit a 40-year high.
The White House cheered Thursday’s news. President Biden has spent the week attempting to stop a stream of Democratic defections from his re-election support after a devastating debate performance and public appearances that haven’t reassured voters concerned about his age.
“The report shows that households are getting some much-welcome breathing room in key areas of their family budget—not just lower inflation but price declines in gas, cars, airfares,” said Jared Bernstein, chair of the Council of Economic Advisers, in an interview. “Our work is far from done, but this is a very solid move in the right direction.”
Write to Sam Goldfarb at [email protected] and Nick Timiraos at [email protected]