PRICES DROP FOR THE FIRST TIME SINCE START OF PANDEMIC (3pET)

(CNN) — Americans weighed down by fast-rising prices for three years just received more encouraging news on the inflation front.

The Consumer Price Index, a measurement of the average change in prices for a commonly purchased basket of goods and services, dropped 0.1% from May, which helped to slow the annual rate of inflation to 3% from 3.3% in May, according to the Bureau of Labor Statistics’ latest report.

Falling gas prices as well as a drop in new and used car prices helped to usher in the first month-on-month decline since May 2020, BLS data showed. On an annual basis, 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 further bolstered hopes that a Federal Reserve rate cut could come sooner than later and help make borrowing money less expensive. Interest rates have been planted for months at a 23-year high as a result of the central bank’s inflation-fighting campaign.

“With another good CPI print under their belt, the window is open for the Federal Reserve to cut interest rates as early as September, and potentially again in December, assuming the inflation data continues to cooperate,” Skyler Weinand, chief investment officer at Regan Capital, wrote Thursday in a note to clients.

Economists were expecting a 0.1% monthly increase and an annual gain of 3.1%, according to FactSet consensus estimates.

Excluding energy and food prices, a 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 — nudging the annual rate of core inflation lower, to 3.3% from 3.4%, and marking a fresh three-year low.

US stocks jumped on the news but quickly gave up those initial gains and settled lower. The blue-chip Dow fell 90 points in morning trading. The S&P 500 dipped into negative territory and the tech-heavy Nasdaq was flat. US Treasury yields fell, which could be good news for consumers: Loans like mortgages are tied to the 10-year yield.

Odds of Fed cutting are growing — but so are the risks

Wall Street is growing 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. That’s up from 73% on Wednesday and around 50% a week ago.

The Fed’s calculus also has shifted somewhat, as the US labor market has become noticeably cooler, with unemployment ticking up for three months in a row to land at 4.1% in June.

“It would be perfectly reasonable, in our opinion, to cut rates in July; however, the Fed is bound by its forward guidance and backward-looking mantra and won’t move until September,” Tuan Nguyen, economist at RSM US, told CNN in an interview on Thursday. “Anything after that will put the economy at serious risk of hitting a hard landing.”

Shelter inflation eases

While falling gas prices did a fair share of the heavy lifting in cooling inflation, the latest CPI showed progress in a critical area: Shelter.

“Shelter and services costs have been the longstanding and persistent trouble spots in the inflation readings, but maybe the tide is starting to turn,” Greg McBride, chief financial analyst at Bankrate, said in a statement.

The shelter index rose just 0.2% during June, the slowest monthly increase in three years. On an annual basis, shelter-related price-hikes rose 5.2%, the coolest reading in two years but still running above overall inflation.

Shelter inflation remains the biggest hurdle to CPI slowing (the category itself is about one-third of the overall CPI). Economists have anticipated a slowdown for quite some time now, as market-rate rents have slowed, but how they’re recorded in the CPI comes with a significant lag, and tabulating overall housing cost inflation is an amorphous process of estimating the rental value of owner-occupied homes.

Cheaper hotel and motel prices helped in the sharp cooling of the overall shelter index (they fell 2.5% for the month); however, rent and owners’ equivalent rents both slowed on a monthly and annual basis.

“Today, the shelter component has finally caught up with what we have been predicting for more than a year now,” RSM’s Nguyen said. “And that (moderation) should continue to be the case in the second half of the year.”

Retailers cutting prices for cost-wary consumers

In recent months, a slew of major retailers have announced price cuts. That trend very well could continue as consumers become more restrained, House said.

“I think you have seen consumers feel and act increasingly strained, and that’s going to make it harder for businesses to pass on prices as we moved throughout the year,” Wells Fargo’s House told CNN earlier this week. “(Discounting) also pressures other retailers. If they want to keep their share of the pie, they’re going to have to compete more on price, given that consumers are more squeezed at this stage of the cycle.”

Core goods prices fell on a monthly basis by 0.1% and are down 1.8% for the 12 months ended in June, according to Thursday’s BLS report.

Food prices saw a modest uptick last month, rising 0.2% overall with grocery and restaurant prices increasing 0.1% and 0.4%, respectively.

Long-lasting effects of high inflation

Prices may not be rising as quickly as they have been, but that might not bring much solace to American households who see that the overall CPI is a good 20% higher than it was in February 2020. (In recent history, that index would typically rise about 10% over a 54-month period, BLS data shows).

The sticker shock of the past three years could leave a lasting impression on consumer behavior, said Michael Weber, an associate professor at the University of Chicago Booth School of Business who has studied how inflation surges affect consumer behavior.

“For many consumers, when we look at the price tags, walking down the aisles of the supermarket, that price tag compared to two, three years ago will be permanently higher, given the cumulative inflation we’ve witnessed over the last three years,” Weber told CNN in an interview.

“It’s ingrained in the memory,” he added.

The Fed closely monitors gauges of near-, medium- and long-term inflation expectations as those could be self-fulfilling prophecies for consumers: If people think prices will be higher in the future, they might spend more now or even demand higher wages. In turn, businesses faced with higher costs might end up raising prices as a result.

While Americans’ near-term inflation expectations have lessened, the fallout from high prices is being seen on a grander stage: The US presidential election.

“People aren’t economists, they don’t think like economists, they don’t look at the rate of change in consumer prices … they’re looking at how much a dozen eggs cost now compared to two years ago,” Bernard Yaros, lead US economist at Oxford Economics, told CNN. “This is really where I think Biden has gotten dinged by, in terms of his public image of his handling of the economy.”

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