Core Inflation Falls to Lowest Level Since April 2021

Inflation in the U.S. continued to moderate in June, as low gas prices and falling prices for new and used vehicles contributed to the first monthly decline in the Consumer Price Index since May 2020. According to the Bureau of Labor Statistics, the Consumer Price Index for All Urban Consumers (CPI-U) increased 3.0 percent over the last 12 months before seasonal adjustment - down from 3.3 percent in May and only the second time since March 2021 that inflation has dropped so low. Meanwhile core inflation, which excludes volatile food and energy prices, came in at 3.3 percent in June, which is also the lowest since April 2021.

Due to its weight in the Consumer Price Index, the cost of shelter continues to be the main driver of inflation these days. Rents and owners' equivalent rents of residences increased 5.1 and 5.4 percent year-over-year in June, respectively, as the index for shelter climbed for the 50th consecutive month. In fact, excluding the impact of shelter, inflation would have fluctuated around the Fed's target level of 2 percent for the past year already, illustrating that housing costs have been the most stubborn driver of elevated inflation lately.

Back in the spring of 2021, when inflation took off, the high readings could largely be explained by the so-called base effect, as prices had fallen sharply at the onset of the pandemic a year earlier, when demand for many goods and services had suddenly dried up. Due to that initial dip in consumer prices, year-over-year comparisons were exaggerated for a while, but towards the end of 2021 inflation became a real concern, which turned into a global crisis when Russia attacked Ukraine, resulting in surging food and energy prices. Now that the conflict in Ukraine has dragged on for more than two years, price levels are measured against already elevated prices, partially explaining the steep drop in inflation in the first half of 2023 and why progress has been notably slower since then.

The latest CPI reading has further cemented hopes of the Fed starting to cut rates this year. According to the CME FedWatch Tool, markets are currently pricing in a 93-percent probability of a first rate cut in September. The FOMC has kept the Federal Funds Rate steady at 5.25 to 5.50 percent since July 2023, putting the breaks on what has been the most aggressive tightening cycle since the early 1980s.