May CPI: Confidence boost

Summary

Today's CPI data were surprisingly soft and will be welcomed by the FOMC as it concludes its two-day meeting this afternoon. Headline CPI was unchanged in the month, the first flat reading since July 2022. Falling energy prices and a very modest increase in food prices helped to keep headline CPI in check. Core CPI increased by a "low" 0.2% (0.16% before rounding), the smallest increase since August 2021. Sticky services inflation finally showed signs of easing, registering 0.2% amid price declines for airfares (-3.6%), motor vehicle insurance (-0.1%) and lodging away from home (-0.1%).

On balance, the May CPI data were encouraging across the board. Tame inflation for food and energy bodes well for consumer spending power, while the deceleration in core CPI suggests that the underlying inflation trend remains firmly downward. The core CPI has risen 3.4% over the past year, the smallest 12 month change since April 2021. That said, inflation remains above the Fed's target, and there have been enough false starts in the past that the FOMC likely will need to see at least a couple more rosy inflation reports to gain the "greater confidence" needed to start reducing the federal funds rate. The materials and post-meeting press conference from the FOMC's meeting later today will shed more light on how the Committee sees inflation evolving alongside its employment mandate, and we expect the median participant on the Committee to project two 25 bps rate cuts by year-end.

Inflation surprises to the downside in May

Consumer prices were flat in May, a tenth softer than the consensus forecast and the first month in which the headline CPI did not increase since July 2022. A 2% decline in energy prices in May restrained inflation in the month, with gasoline prices sliding 3.6% and energy services prices falling a smaller 0.2%. Food prices posted a meager 0.1% increase, with flat grocery store prices partially offset by a 0.4% increase in prices for food consumed away from home. It is still early in the month, but so far there are preliminary signs that the slide in gasoline prices continued in June, which bodes well for another tame increase in headline inflation when the next CPI report comes around. The headline CPI has increased 3.3% over the past year, which marks an improvement on the 4.0% increase registered in May 2023 but is still about a percentage point faster than the pace prevailed on the eve of the pandemic.

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