Big drop in US infla­tion raises hopes that ‘fever is break­ing’ after rate rises

US infla­tion fell sharply to 3 per cent in June, send­ing the dol­lar lower and high­light­ing the Fed­eral Reserve’s rel­at­ive suc­cess at bear­ing down on price pres­sures.

The improved pic­ture in yes­ter­day’s data stands in sharp con­trast to other advanced eco­nom­ies such as the UK, where the Bank of Eng­land is strug­gling to con­trol infla­tion of 8.7 per cent.

US mar­kets reacted pos­it­ively to the data, with the main stock indices hit­ting 15-month highs. The two-year Treas­ury yield, which moves with interest rate expect­a­tions, fell to a two-week low of 4.73 per cent, while the US dol­lar index hit its weak­est point in 15 months.

The annual increase in the con­sumer price index slowed from 4 per cent in May to 3 per cent in June, the slow­est rate of infla­tion since March 2021, com­pared with expect­a­tions of 3.1 per cent.

“After a pun­ish­ing stretch of high infla­tion that eroded con­sumers’ pur­chas­ing power, the fever is break­ing,” said Bill Adams, chief eco­nom­ist at Comer­ica Bank.

The head­line rate of infla­tion has been mov­ing closer to the Fed’s 2 per cent tar­get after peak­ing at more than 9 per cent last year. However, core infla­tion, which strips out volat­ile food and energy costs, has proved more resi­li­ent, rais­ing expect­a­tions that the US cent­ral bank will still need to lift interest rates fur­ther. Core CPI fell more mod­estly, from 5.3 per cent to 4.8 per cent.

“Head­line infla­tion is com­ing down, but . . . there is still quite a dis­tance to go from 4.8 per cent to where the Fed wants core infla­tion to be at 2 per cent,” said Tor­sten Slok, chief eco­nom­ist at Apollo Global Man­age­ment. “Taken with the employ­ment report, this is still likely to mean another rate increase.”

Labour mar­ket data released last week sug­ges­ted that the Fed’s aggress­ive rate rises were begin­ning to cool the eco­nomy, with jobs growth slow­ing.

However, it also high­lighted con­tin­ued infla­tion­ary pres­sures, with unem­ploy­ment still close to a multi-dec­ade low and wages grow­ing well above the levels con­sidered con­sist­ent with the Fed’s tar­get infla­tion rate.

The Fed has raised its bench­mark interest rate to a range of 5 to 5.25 per cent from close to zero at the start of 2022. Offi­cials kept rates steady at their most recent policy meet­ing in June to take stock of the effect of pre­vi­ous rises but have made clear they expect fur­ther increases before the end of the year.

Sophia Dros­sos, an eco­nom­ist at Point72 Asset Man­age­ment, said the Fed was likely to raise rates this month but added that the com­bin­a­tion of yes­ter­day’s data and tent­at­ive signs of cool­ing in the labour mar­ket “rein­forces the view that the path for the Fed is more uncer­tain after July”.

“What we’re see­ing is con­sist­ent with the mar­ket scal­ing back tight­en­ing expect­a­tions after the July meet­ing,” she said, “but it doesn’t seem that it should be pri­cing in scope for rate cuts this year. This is con­sist­ent with higher for longer, per­haps ‘one and done’ as the Fed goes on pause and con­siders its next move.”

Whereas the Fed appears to be clos­ing in on the end of its mon­et­ary tight­en­ing cam­paign, the BoE and the European Cent­ral Bank are expec­ted to plough on with sev­eral more rate rises this year.

Accord­ing to futures mar­kets, the BoE is fore­cast to lift its bench­mark rate another per­cent­age point this year to 6 per cent by early 2024. The ECB is pro­jec­ted to deliver about half a per­cent­age point more of rate rises this year. China’s eco­nomy teetered on the brink of defla­tion in June, with flat annual CPI, adding to calls for more stim­u­lus.