U.S. inflation cooled to 3.5% in June as gas prices fell

U.S. inflation cooled last month as the cost of gas, clothes, and used cars fell, providing some relief to consumers, while underlying price pressures also cooled.

U.S. inflation cooled last month as the cost of gas, clothes, and used cars fell, providing some relief to American consumers, while underlying price pressures also cooled more than expected.

Prices dropped 0.4 per cent from May to June, the largest monthly drop in four years, the Labor Department said Tuesday. On a yearly basis, inflation declined to 3.5 per cent, down from a year-over-year gain of 4.2 per cent in May and lower than many economists expected.

Yet oil prices rose for a second day Tuesday as the United States renewed attacks on Iran and President Donald Trump announced a new blockade in the Strait of Hormuz, a key shipping route for about one-fifth of the world’s oil. And many Americans have soured on the economy after five years of elevated inflation, posing a risk to Trump and Republicans in the upcoming midterm elections.

Still, excluding the food and energy categories, core prices were unchanged in June, a positive sign that underlying inflation is cooling. On a yearly basis, core prices rose just 2.6 per cent, down from 2.9 per cent the previous month. Core inflation remains above the Federal Reserve’s target of two per cent.

The core figures suggest that the gas price spike from the Iran war, while it pushed up airfares and some other costs, hasn’t so far led to broad-based, sustained inflation, economists said.

“This reading is very much in the camp that the inflation we’ve had this year is transitory,” said Michael Metcalfe, head of macro strategy at State Street Markets.

“Yes, gas prices went up, but nothing else did, more or less.”

Tuesday’s report likely reduces pressure on the Fed to boost its short-term interest rate to combat inflation. Last month, Fed officials left their key rate unchanged at about 3.6 per cent.

“Today’s report gave some breathing room for the Federal Reserve in deciding whether and when to raise interest rates,” Kathy Bostjancic, chief economist at Nationwide Financial, said.

Fed Chair Kevin Warsh, in written testimony to the House Financial Services Committee, said Tuesday that the Fed has “no tolerance” for high inflation which he pledged would become “a thing of the past.” Yet he provided no hints about what steps the Fed may take in coming months.

Warsh will face questions later Tuesday from members of Congress.

A wider range of prices cooled last month than economists had forecast. Electricity prices, which have been elevated by spiking demand from data centres, fell one per cent from May to June, though they are still four per cent higher than a year ago. Clothing prices dropped 0.6 per cent from May to June but are 3.9 per cent more expensive than a year earlier.

Groceries rose 0.2 per cent from May to June and are up 2.7 per cent from last year, while apartment rental costs cooled, rising just 0.1 per cent last month and 2.8 per cent from a year ago.

The inflation-fighters at the Fed remain sharply divided over next steps, according to minutes of their June 16-17 meeting. About half of policymakers support raising interest rates by the end of the year to cool borrowing, spending, and price increases, the minutes showed. Another half are willing to wait for signs that inflation may resume falling as gas prices decline, though the minutes predate the recent flare-up of violence in the Middle East.

And the situation in the Middle East continues to change hour to hour. On Tuesday, the price for a barrel of Brent crude oil, the international standard, climbed 4.6 per cent to US$87.13 after the United States and Iran each said the Strait of Hormuz is under its control. Gas prices have also risen about 6 cents a gallon in the past week, to a nationwide average of $3.86 a gallon.

“Today’s number is a very good reading, but so much is going to depend on what happens in the Middle East,” Bostjancic said.

Many Fed officials have flagged massive investments in the build out of artificial intelligence infrastructure as a factor that could worsen inflation by pushing up prices for memory chips and other semiconductors, as well as electricity. With chips so much more expensive, companies like Apple, Microsoft, and Dell have announced price increases for laptops, tablets, and video game consoles.

Other Fed officials have offered conflicting views on what steps the Fed could take next. On Monday, Fed governor Christopher Waller said he was worried about core inflation, which he noted had risen from three per cent last December to 3.4 per cent in May, according to the Fed’s preferred measure. He pointed out that the cost of more than two-thirds of services have risen by three per cent or more compared with a year ago.

“If we get another hot reading on core inflation this week, then the (Fed) will need to consider tightening monetary policy in the near term,” Waller said in a speech in New York.

But last week John Williams, president of the Federal Reserve Bank of New York, said that if core inflation stays at a 0.2 per cent monthly pace for the rest of this year, the Fed could avoid hiking rates. Tuesday’s data is along the lines of what Williams wants to see.

Other signs of where prices are headed are mixed. The Federal Reserve Bank of New York said last week that a survey found that nearly half the companies in its region that have paid tariffs still plan to lift their prices further.

Separately, Walmart last week said it was rolling back prices on thousands of items, including ground beef, potato chips, toys, and clothes. President Donald Trump praised the move on social media and sought to take credit for the reduction, though the company did not mention Trump in its announcement.