A key economic measure from the Federal Reserve revealed Friday that May’s inflation rate was the lowest in three years.
A report from the Commerce Department indicated that the Personal Consumption Expenditures (PCE) price index rose by a seasonally adjusted 0.1% for the month and by 2.6% year over year. This annual figure was a slight decline from the April level.
Both numbers met Dow Jones expectations. May saw the lowest annual inflation rate since March 2021, marking the first time this economic cycle that inflation has fallen below the Fed’s 2% target.
Including food and energy prices, headline inflation remained stable on a monthly basis and increased by 2.6 percent from a year earlier, in line with expectations.
“This is further evidence that monetary policy is working and that inflation is gradually cooling,” San Francisco Fed President Mary Daly said in an interview on CNBC’s “Squawk Box.” “This is a relief for businesses and households that have struggled with persistently high inflation. It’s good news for the workings of policy.”
The Fed prefers the PCE inflation measure over the more commonly followed Consumer Price Index (CPI) from the Department of Labor’s Bureau of Labor Statistics. PCE is a broader measure of inflation and takes into account changes in consumer behavior, such as switching to cheaper alternatives when prices rise.
While the Fed officially tracks the headline PCE, officials typically believe the underlying figure is a better indicator of longer-term inflation trends.
In addition to inflation, the Bureau of Economic Analysis report showed that personal income rose 0.5% in May, beating the estimate of 0.4%. However, consumer spending rose only 0.2%, falling short of the 0.3% forecast.
Monthly price stability was supported by a 0.4% decline in goods and a 2.1% decline in energy prices, which offset a 0.2% increase in services and a 0.1% increase in food prices.
Despite this, housing costs continued to rise, rising 0.4% for the fourth straight month. Persistently high housing costs have prevented the Fed from lowering interest rates as some had expected this year.
Following the report, stock market futures were modestly positive, while Treasury yields fell during the session.
Investors have had to adjust their expectations for the Fed’s rate plans this year. At the start of 2024, traders expected at least six rate cuts; now, they expect just two, starting in September. At their June meeting, Fed officials indicated just one reduction for the year.
“The lack of surprise in today’s PCE number is a relief and will be welcomed by the Fed,” said Seema Shah, chief global strategist at Principal Asset Management. “However, the policy path is not yet certain. Further deceleration in inflation, ideally combined with further evidence of labor market easing, will be needed to pave the way for a first rate cut in September.”
The Fed set an inflation target of 2% and began raising interest rates in March 2022, having previously viewed price increases as temporary effects of the Covid pandemic. The central bank’s last rate hike was in July 2023, bringing the benchmark overnight lending rate to a range of 5.25% to 5.50%, the highest in about 23 years.
Recent economic data suggests that the economy has managed to withstand the Fed’s aggressive monetary tightening. Gross domestic product (GDP) grew at an annualized rate of 1.4% in the first quarter and is expected to expand 2.2% in the second quarter, according to the Atlanta Fed.
There have been some signs of weakness in the labor market recently, with pending jobless claims reaching the highest level since November 2021. However, the unemployment rate remains low at 4%, although it is slowly rising.