Headline inflation falls to lowest in 3 years, helping case for rate cut

America’s battle with stubborn inflation is finally turning a corner as the Consumer Price Index dips to an unexpected low in June
By Sam Bourgi
•
12 July 2024
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U.S. inflation cooled more than expected in June, sending a strong message to the Fed that its interest-rate policy is working.

According to the Labor Department, the Consumer Price Index (CPI) dipped 0.1% in June, putting the annual rate at 3%, which is the lowest in more than three years.

Economists were expecting CPI to increase by 0.1% from May and 3.1% year over year.

Core inflation, which excludes volatile food and energy prices, rose 0.1% from May and 3.3% compared to a year ago. Both readings were below economist expectations.

The June CPI report adds to a growing body of evidence showing a broad slowdown in prices. The Fed’s preferred inflation gauge, the core PCE index, fell to 2.6% in May—the lowest in more than three years.

Inflation is cooling at a time when the U.S. economy is losing steam. Consumer spending is weakening, unemployment is trekking higher, and service activity posted a surprise drop at the end of the second quarter.

Although the Fed seems to be confident in its ability to engineer a “soft landing,” not everyone is convinced the landing will be smooth.

A not-so-soft landing?

Economists have grown more skeptical about the Fed’s ability to cool inflation without setting off a recession. In their view, the Fed is probably waiting too long to cut interest rates.

Pantheon Macroeconomics’s Ian Shepherdson thinks the recent uptick in unemployment is especially concerning.

“The key danger now is that the rise in unemployment becomes self-sustaining, as consumers become more cautious and businesses no longer fear being able to rehire if they lay off underutilized workers,” the economist wrote.

The national unemployment rate, at 4.1%, looks good on paper. But it’s increased from 3.5% since last July and is getting dangerously close to triggering the dreaded “Sahm Rule.”

Developed by economist Claudia Sahm, the Sahm Rule says recession is imminent when the unemployment rate’s three-month average jumps by at least half a percentage point from its 12-month low.

Another month of higher unemployment could trip that signal.

One reason the Fed has been reluctant to cut rates could be its recent poor performance in predicting inflation. During Covid, central bankers told Americans not to worry about inflation. Soon after, CPI spiked to 9.1%, a 40-year high.

“One thing that has surprised me is that there has been a large group on the FOMC that appeared to just be a little bit more nervous about inflation coming down that last mile than I am,” said David Mericle, the chief U.S. economist at Goldman Sachs.

That could explain why policymakers have decided to buy themselves some time.

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