WASHINGTON (Reuters) – US monthly inflation was unchanged in May as a modest increase in the cost of services was offset by the largest drop in goods prices in six months, drawing the Federal Reserve closer to start cutting US interest rates later this year.
The report from the Commerce Department on Friday also showed US consumer spending rose marginally last month.
Underlying prices advanced at the slowest pace in six months, raising optimism that the central bank could engineer a much-desired "soft landing" for the economy in which inflation cools without triggering a recession and a sharp rise in unemployment.
Traders raised their bets for a Fed rate cut in September.
"This was a very Fed-friendly report that should keep the September rate cut in play, while at the same time increasing investor confidence that moderate economic growth can be maintained even as rates stay higher for longer," said Scott Anderson, chief US economist at BMO Capital Markets.
"The sharp slowdown in core inflation is just what the doctor needed to see to keep the economy on the soft-landing glide-path."
The flat reading in the personal consumption expenditures (PCE) price index last month followed an unrevised 0.3 per cent gain in April, the Commerce Department's Bureau of Economic Analysis said. It was the first time in six months that PCE inflation was unchanged. Goods prices fell 0.4pc, the biggest drop since November.
There were big declines in prices of recreational goods and vehicles as well as furnishings and durable household equipment.
The price of gasoline and other energy goods dropped 3.4pc, the biggest slide in six months. Clothing and footwear were also cheaper, while food prices rose marginally.
The cost of services increased 0.2pc, lifted by higher prices for housing and utilities as well as healthcare. Financial services and insurance costs declined 0.3pc after rising for five straight months. These costs, together with housing, have been among the major drivers of services inflation.
In the 12 months through May, the PCE price index increased 2.6pc after advancing 2.7pc in April. Last month's inflation readings were in line with economists' expectations.
US inflation is receding after spiking in the first quarter as 525 basis points worth of rate hikes from the Fed since 2022 cool domestic demand. Inflation, however, continues to run above the central bank's 2pc target.
Financial markets saw a roughly 68pc chance that the Fed's policy easing would start in September compared to about 64pc before the data, though policymakers recently adopted a more hawkish outlook. The US central bank has maintained its benchmark overnight interest rate in the current 5.25pc-5.50pc range since last July.
Economists were divided on whether the Fed would still reduce borrowing costs twice this year amid solid wage growth. The release of the US employment report for June next Friday could shed more light on the monetary policy outlook.
Stocks on Wall Street were trading largely higher. The dollar was little changed against a basket of currencies. US Treasury prices were mixed.
SPENDING RISES MODERATELY
Excluding the volatile food and energy components, the PCE price index edged up 0.1pc last month, the smallest gain since November. That followed an upwardly revised 0.3pc rise in April.
The so-called core PCE price index was previously reported to have climbed 0.2pc in April. Core inflation increased 2.6pc on a year-on-year basis in May, the smallest advance since March 2021, after rising 2.8pc in April.
It rose at a 2.7pc annualized rate over the past three months, slowing from a 3.5% pace in April.
The Fed tracks the PCE price measures for its inflation target. Monthly inflation readings of 0.2pc over time are necessary to bring inflation back to target.
PCE services inflation excluding energy and housing also ticked up 0.1pc last month after advancing 0.3pc in April. This measure is being watched by policymakers to measure progress in lowering price pressures.
Consumer spending, which accounts for more than two-thirds of US economic activity, increased 0.2pc last month after rising 0.1pc in April, the report also showed. Spending was supported by a 0.3pc gain in services, mostly outlays on hospital care, housing and utilities as well as air transportation. Services spending increased 0.4pc in April.
Goods spending rebounded 0.2pc, lifted by outlays on prescription medication, recreational goods and vehicles, and clothing and footwear. Spending on goods fell 0.5pc in April.
Inflation fatigue, higher borrowing costs as well as the exhaustion of excess savings accumulated during the COVID-19 pandemic are holding back spending. Nonetheless, consumer spending remains underpinned by a resilient labour market, which continues to generate strong wage gains. Personal income increased 0.5pc after climbing 0.3pc in April. Wages shot up 0.7pc, which some economists said could concern policymakers.
Income at the disposal of households after accounting for inflation and taxes rose a solid 0.5pc. Consumers saved more, lifting the US saving rate to 3.9pc from 3.7pc in April.
Spending adjusted for inflation rebounded 0.3pc after slipping 0.1pc in April. The rise in the so-called real consumer spending left growth in consumption this quarter on track to match the first quarter's 1.5pc pace.
The Atlanta Fed is currently estimating US gross domestic product to rise at a 2.2pc rate in the second quarter. The economy grew at a 1.4pc pace in the first quarter.
"There was no inflation in May, but there was also no indication of the kind of soft demand – undermined by slower income growth – the Fed believes necessary to keep inflation on a low track," said Chris Low, chief economist at FHN Financial.