US inflation softens more than expected, boosting Fed cut hopes

US inflation cooled more than expected last month, which has raised expectations that the Federal Reserve could cut rates sooner.

The consumer price index fell 0.1% from May to June, which lowered the annual rate of inflation to 3.0% from 3.5%, marking the lowest point in a year and undershooting forecasts of 3.1%.

According to the Bureau of National Statistics, energy costs rose at a slower pace than anticipated, driven by declines in gasoline and fuel oil, although utility gas service costs did accelerate.

Inflation eased for shelter and transportation and stayed flat for apparel, while prices continued to decline for new vehicles and used cars. Food prices, on the other hand, edged up 2.2%.

The annual core rate of inflation also fell to 3.3% from 3.4%. This is the first monthly decline in price growth since 2020, and the lowest rate of headline inflation for 12 months.

The data prompted traders to increase the chances of a near-term interest rate cut following this data print to a greater than 80% chance for the September Federal Reserve meeting.

Bond prices improved immediately following the data price, with yields on the US 10-year Treasury yield dropping below 4.20% for the first time since late March.

“The Fed will cut soon,” Pantheon Macroeconomics chief economist Ian Shepherdson said, adding: “June’s CPI data bring more evidence of broad-based disinflation, giving the Fed the green light to ease multiple times this year.”

ING economist James Knightley said: "This report clearly supports the argument that the Fed can start to loosen monetary policy a little from restrictive territory to 'slightly less restrictive' territory at upcoming meetings."

The monthly rate of inflation was "the key number", he said, with twelve more similar prints in a row bringing annual CPI to the Fed's 2% target.

"A July rate cut remains highly unlikely, but 23bp of a 25bp cut is now priced for September. Between now and then we expect to see more evidence of a cooling jobs market and decelerating consumer spending growth.

"With the Fed keen to avoid a recession and achieve the targeted “soft landing” we think the Jackson Hole Conference at the end of August will be the venue for the Fed to signal more explicitly that interest rate cuts are coming. We continue to see three rate cuts this year versus the market pricing of two."

Quincy Krosby, chief global strategist for LPL Financial, noted that equity futures quickly turned positive and yields for the policy-sensitive 2-Year edged lower as did the 10-Year.

"Today's CPI release should offer more confirmation for the data-dependent - and hesitant - Fed to begin the interest rate easing cycle at its September 18 meeting. 

"Still, the Fed could very well lower rates sooner than September if the labor market softens at a faster clip. Fed Chair Powell has increasingly invoked the Fed's maximum employment mandate as a rationale for lowering rates if necessary to support the labor market, and hence the economic backdrop.

"For the market, clearly the preferred basis for easing rates is predicated on inflationary pressures cooling at a steady pace rather than on an economy losing momentum."