US inflation fell more than expected last month to more than two-year low but core prices remain elevated, meaning expectations for the Federal Reserve's next few moves are still not definite.
The US consumer price index (CPI) in May was 4.0% higher than a year ago, easing from a headline CPI inflation rate of 4.9% in April, which was lower than the Wall Street consensus forecast of 4.1%.
On a month-on-month basis headline CPI inflation fell to 0.1% from 0.4% the month before and again below the average estimate of 0.2%.
The dollar dropped and Wall Street futures spiked as expectations of another Fed interest rate hike at its next policy meeting today and Wednesday fell closer to zero.
However, core CPI inflation, which excludes more volatile prices such as energy and food, eased less than the headline figures. Core CPI fell to 5.3% on the year from 5.4% a month ago, as forecast, but on the month remained at 0.4%.
This led to expectations from some that Fed chief Jerome Powell and colleagues on the Federal Open Market Committee could signal that one more hike might be needed later in the summer.
Naeem Aslam, chief investment officer at Zaye Capital Markets, was not one of them. “The CPI data has shown clearly that the Fed needs to take summer off now with respect to their monetary policy,” he said.
Aslam said as headline inflation is slowing down traders are “already expecting some kind of a pause from the Fed or at least some hints coming in their meeting”.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, said his 'base case' is that the Fed has now finished with its current cycle of policy tightening, but said it could be "close", depending on how economic data comes out in the coming few months.
Shepherdson said that the fall in headline inflation was thanks to the anniversary of a large monthly increase in May last year, "and a similar story in June means the y/y rate should drop to just 3.1%".
"Such rapid headline disinflation will make it harder for the Fed to justify raising rates again, but we can’t rule out a July hike yet. Everything depends on the data, but we expect both a softer employment report and a 0.2% core CPI for June, so our base case remains that the Fed is done. But it will be close."
Others saw things differently.
As core price inflation “still as high as 5.3%” and core prices rising on the month, “the Fed is likely to signal tomorrow that it is minded to hike interest rates at the late-July FOMC meeting,” said Paul Ashworth, chief North America economist at Capital Economics.
He said headline CPI inflation fell, thanks to favourable base effects and another sharp drop back in energy prices last month.
Energy prices fell 3.6% on the month, with annual energy inflation now at -11.7%, following a further drop in gasoline prices, with utilities pricing also trending down in the wake of the earlier collapse in natural gas spot prices.
Food prices increased just 0.2% on the month, helped by a slump in egg prices after the earlier Avian-flu related distortion stopped having an effect.
The biggest effects driving core CPI were rents and used car prices, said Shepherdson, with the former seen to be heading for a "steep slowing" later this year and the latter expected to "fall over the summer, likely starting as soon as June".