Cooling US inflation bolsters September rate cut hopes

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. prices increased moderately in June as the declining cost of goods tempered a rise in the cost of services, underscoring an improving inflation environment that could position the Federal Reserve to begin cutting interest rates in September.

The report from the Commerce Department on Friday also showed consumer spending slowed a bit last month. Signs of easing price pressures and a cooling labor market could boost the confidence of Fed officials that inflation is moving toward the U.S. central bank's 2% target. The Fed will hold its next policy meeting on July 30-31.

"The key question now is whether the positive momentum we've seen over the last three months will be disrupted heading into the September meeting," said Olu Sonola, head of U.S. economic research at Fitch Ratings. "With one eye on recent labor market developments, the Fed is now likely to use the meeting next week to set the stage for a September rate cut."

The personal consumption expenditures (PCE) price index nudged up 0.1% last month after being unchanged in May, the Commerce Department's Bureau of Economic Analysis reported.

The increase in PCE inflation was in line with economists' expectations. Goods prices dropped 0.2% after falling 0.4% in May. Prices for motor vehicles and parts declined 0.6%. Furnishings and durable household equipment prices dropped for a third straight month, but the cost of other long-lasting manufactured goods rebounded 1.8%.

Prices for gasoline and other energy goods decreased 3.5% after falling 3.4% in May. Clothing and footwear were cheaper for a second straight month.

But the cost of services increased 0.2%, matching May's gain. Housing and utilities costs advanced 0.2%, the smallest increase since March 2023, after rising 0.4% in May. Rents have been one of the key drivers of inflation. Financial services and insurance costs climbed 0.3%.

Prices for transportation services, however, dropped for a third straight month. In the 12 months through June, the PCE price index climbed 2.5%. That was the smallest year-on-year gain in four months and followed a 2.6% advance in May.

Excluding the volatile food and energy components, the PCE price index rose 0.2% last month. The so-called core PCE inflation gain was 0.182% before rounding. May's unrounded figure was revised up to 0.127% from the previously reported 0.083%. April's core PCE inflation was upgraded to 0.261% from the previously estimated 0.259% rise.

These upward revisions explain the slightly faster-than-expected increase in core inflation in the second quarter.

In the 12 months through June, core PCE inflation advanced 2.6%, matching May's rise. Core inflation increased at a 2.3% annualized rate in the three months through June, sharply slowing from the 2.7% pace in May.

The Fed tracks the PCE price measures for monetary policy.

"The much-improved inflation readings indicate that the flare up in inflation in the first quarter was temporary," said Kathy Bostjancic, chief economist at Nationwide. "Moreover, if rental inflation has finally decelerated as recent data suggest, then inflation looks to be back on a sustained downward trend."

Demand in the economy has cooled in response to the Fed's aggressive monetary policy tightening in 2022 and 2023. Economic growth averaged 2.1% in the first half of this year compared to 4.2% in the second half of 2023.

Stocks on Wall Street were trading higher. U.S. Treasury yields fell, while the dollar was slightly lower against a basket of currencies.

TEPID INCOME GROWTH

The Fed has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range since last July. It has hiked its policy rate by 525 basis points since 2022.

Subsiding inflation and easing labor market conditions have led financial markets to anticipate three rate cuts this year, starting in September.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased 0.3% last month after an upwardly revised 0.4% gain in May, the report also showed. Spending in May was previously reported to have risen 0.2%. Data for April was also revised higher.

Spending last month was driven by a 0.4% rise in services, reflecting increases in housing and utilities, financial services and insurance, healthcare and international travel.

Goods outlays ticked up 0.1% as a cyberattack at software systems provider CDK hit operations at several auto dealerships during the second half of June.

Lower gasoline prices also weighed on receipts at service stations. But spending on nondurable goods like pharmaceutical and other medical products rose. When adjusted for inflation, consumer spending gained 0.2% after climbing 0.4% in May.

With income growth cooling in tandem with a loosening labor market, consumer spending is likely to remain moderate. Nonetheless, the pace would probably be sufficient to keep the economy chugging along.

Personal income rose 0.2% last month after advancing 0.4% in May. Income at the disposal of households after adjusting for inflation and taxes nudged up 0.1% after rebounding 0.3% in May, leaving consumers to tap into savings and also save less.

Wages increased 0.3% after surging 0.6% in May. The previously reported steady rise in the saving rate over the prior months was revised away. The saving rate slipped to 3.4%, the lowest level since December 2022, from 3.5% in May.

Bank of America Securities economists estimated that excess savings accumulated during the COVID-19 pandemic at around $400 billion and projected they would last through year-end at the current pace of rundown.

"Rising savings had suggested consumers were pulling back on spending and saving more for possibly precautionary reasons," said Veronica Clark, an economist at Citigroup.

"But spending overall still seems to be slowing with softer than expected income. If anything, a very low savings rate would suggest risk of an even sharper pullback in spending as the labor market weakens."

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Paul Simao, Kirsten Donovan)