The consumer price index declined by 0.4% in June for the first monthly decline since 2020, during the pandemic, according to data released by the Bureau of Labor Statistics on Tuesday.
The monthly drop in the CPI—or deflation, when prices fall instead of rise—had been widely expected as the reopening of the Strait of Hormuz led oil and gas prices to plunge.
But the magnitude of the decline was much larger than forecast, and the June data was most surprising in the core measure of CPI, which strips out food and energy.
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Core CPI was unchanged in June as many other categories in the inflation report also showed falling prices, including used cars, education, apparel and commodities.
The broad decline in inflation might suggest that demand destruction took place in June. Before the reopening of the Strait of Hormuz, wage growth was negative for most Americans after adjusting for inflation. Rising gasoline prices had also offset most of the tax refunds sent out this year.
Even airfares, which had been expected to continue rising sharply because of World Cup demand, posted only a modest increase on the month.
With this new inflation report, in which the top-line CPI rose by 3.5% annually, we should be fairly certain that the Federal Reserve will not raise interest rates at its meeting on July 28-29.
While the Fed’s most recent interest rate forecast, or dot plot, pointed to one rate hike this year, we don’t see many reasons for the Fed to become more restrictive.
The new data should reaffirm our base case that there will be no rate hikes this year, as inflation is more likely than not to cool further.
The renewed tensions over the Strait of Hormuz will complicate the inflation outlook. That is why there are also not many reasons to expect rates to fall too early either, especially with the job market continuing to move along at a very solid pace.
Inside the data
Overall inflation fell by 0.4% in June after rising by 0.5% the previous month, bringing the year-over-year rate down to 3.5% from 4.2%.
Core CPI was unchanged on the month, while the year-over-year rate fell to 2.6% from 2.9%.
The bulk of the decline came from energy prices, which fell by 5.7% on the month. Gasoline prices dropped by 9.7%.
Housing prices were unchanged in June, contributing significantly to the surprising slowdown in core inflation.
Education and medical care both posted negative monthly inflation readings.
The takeaway
The downside surprise in June’s CPI report is certainly a welcome sign for the Fed as it continues to balance the inflation risks stemming from the war in Iran.
But given how quickly the situation could escalate, especially following the developments in recent days, inflation could reaccelerate.
That should allow the Fed to be less hawkish, but uncertainty around the inflation outlook toward the end of the year remains elevated.
