A key measure of underlying U.S. inflation fell for a second straight month in May, a surprise to Federal Reserve officials who are looking for signs they can start cutting interest rates.

Data from the U.S. Bureau of Labor Statistics showed that the core CPI, which excludes food and energy costs, climbed 0.2% from April, slowing to 3.4% year-on-year, the lowest level in more than three years. Dragged down by falling gasoline prices, the overall U.S. CPI rose 3.3% year-on-year, the lowest level in nearly two years.

Combined with a cooling in core CPI in April, this could represent the early stages of a resumption of inflation’s downward trend. But policymakers have stressed that they need to see a few months of subsiding inflation pressures before considering rate cuts, especially as the latest nonfarm payrolls report has reignited debate over how restrictive policy actually is.

Economists said the data increased the odds that Fed policymakers would project two rate cuts in 2024 when they release updated projections later. Traders are now fully pricing in two rate cuts from the Fed this year, with the first expected to come in November. Interest rate futures show an increase in bets that the Fed will start cutting rates in September.

Hours later, the Federal Reserve will wrap up a two-day policy meeting in Washington. Fed officials are widely expected to keep interest rates at a 20-year high for a seventh straight time. Officials can still adjust their quarterly economic forecasts based on the CPI data, which Fed Chairman Jerome Powell has said has happened in the past when major data is released mid-meeting.

“I think it’s good news for the committee,” said James Bullard, former president of the St. Louis Fed. “They had been looking for a weaker report and they got it. They may need more of that in order to move forward with rate cuts, but this report does keep hope alive for those who had been expecting a rate cut sooner.”

While the Bureau of Labor Statistics reports data with only one decimal point, officials have increasingly broken it down further to get a fuller picture of where inflation is headed. Using two decimal points, the core CPI rose 0.16% month-over-month.

Policymakers also stressed that one month's data is not indicative of a trend. The core CPI rose at an annualized rate of 3.3% over the past three months, down from 4.1% in April.

Institutional analyst Anna Wong pointed out that "the May CPI report is encouraging, and we expect a series of similar reports this summer, laying the foundation for the Fed to start cutting interest rates in September."

However, Joseph LaVorgna, chief economist at SMBC Nikko Securities, said, "The Fed needs three more months of very friendly inflation data before it can cut rates in September. If they start to ease monetary policy, or talk about further easing monetary policy, it will complicate the prospect of inflation returning to 2%."

Housing prices rose 0.4%, outweighing a drop in gasoline prices, the report said. Owner's equivalent rent, a subset of housing prices that is the largest single component of the CPI, also rose at a similar pace.

“Unfortunately, home and apartment prices continue to rise, which remains the primary driver of inflation,” said Robert Frick, corporate economist at Navy Federal Credit Union. “Until these housing costs begin their long-awaited decline, we will not see a significant decline in the CPI.”

The CPI report showed a broad decline in service sector inflation, including the first drop in auto insurance costs since 2021. That has been a major driver of inflation in recent months. Airline fares posted their biggest drop in nearly a year. Prices for cable, satellite and streaming services fell by the most in nearly two decades.

Unlike the services sector, goods prices have continued to fall for much of the past year, providing some comfort to consumers, although economists expect this to be less reliable in the future disinflation process.

The core CPI, which excludes food and energy, was flat in May after falling in the previous two months. Used-car prices rose the most this year, while prescription drug prices rose the most since January 2023.

A separate report on Wednesday that combined inflation data with wage data released last week showed real incomes rose 0.8% from a year earlier, the biggest gain in three months.

The article is forwarded from: Jinshi Data