A key measure of underlying U.S. inflation stepped down for a second month in May, a pleasant surprise for U.S. Federal Reserve officials looking for signs that they can start to lower interest rates.  

The so-called core consumer price index — which excludes food and energy costs — climbed 0.2 per cent from April, U.S. Bureau of Labor Statistics figures showed. The year-over-year measure rose 3.4 per cent, cooling to the slowest pace in more than three years, according to data out Wednesday.

The figures, taken with the deceleration in the core CPI in April, may represent the early stages of inflation resuming a downward trend. But policymakers have stressed that they’d need to see several months of price pressures receding before they consider lowering interest rates, especially with the latest jobs report reigniting the debate over how restrictive policy actually is.

Stock futures and Treasuries rallied across the curve, pushing both two-year and 10-year yields down about 14 basis points. Traders fully priced in two rate cuts by the Fed this year, with the first move coming in November — two days after the presidential election.

Economists see the core gauge as a better indicator of underlying inflation than the overall CPI. That measure was flat from the prior month — the tamest in almost two years, dragged down by cheaper gasoline — and 3.3 per cent from a year ago.

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The report lands just hours before the Fed is set to conclude its two-day policy meeting in Washington, where officials are widely expected to keep rates at a two-decade high for a seventh straight time. Officials can still adjust their quarterly economic projections depending on what the CPI data show, which Chair Jerome Powell said has happened before when major data are released mid-meeting.

“I think this was good news for the committee. They’ve been looking for a softer report, they got it here,” Jim Bullard, former president of the St. Louis Fed, said on Bloomberg Television. “We would need more news going in this direction in order to forge ahead with our easing policy.”

“But it does keep hope alive for those that have been looking for an earlier rate cut,” he added.

While the figures are reported to one decimal point by the BLS, officials have been increasingly drawing the numbers out further to get a more comprehensive picture of the direction inflation is headed. On a two-decimal basis, core CPI rose 0.16 per cent.

Policymakers also stress that a single month of data doesn’t make a trend. Core CPI over the past three months increased an annualized 3.3 per cent, down from 4.1 per cent in April’s calculation.

What Bloomberg Economics says...

“May’s CPI report is encouraging — and the core PCE deflator will likely be even more so. We anticipate a string of similar reports this summer, setting the stage for the Fed to start cutting rates in September.”

— Anna Wong, Eliza Winger and Estelle Ou

Shelter prices, which is the largest category within services, climbed 0.4 per cent, more than offsetting the decline in gasoline, BLS said. Owners’ equivalent rent — a subset of shelter, which is the biggest individual component of the CPI — advanced at a similar pace.

Excluding housing and energy, services prices were largely unchanged from April, the weakest since September 2021, according to Bloomberg calculations. While central bankers have stressed the importance of looking at such a metric when assessing the nation’s inflation trajectory, they compute it based on a separate index.

That measure, known as the personal consumption expenditures price index, doesn’t put as much weight on shelter as the CPI does. That’s part of the reason why the PCE is trending closer to the Fed’s two per cent target.

The PCE, which will come out with May data later this month, draws from the CPI as well as certain categories within the producer price index, which is due Thursday.

Services inflation declined broadly, including the first drop in car insurance costs since 2021. That category has been a major driver of price pressures in recent months. Airfares dropped by the most in almost a year. Prices for cable, satellite and streaming services declined by the most in nearly 20 years.

Unlike services, a sustained decline in the price of goods over most of the past year has largely been providing some relief to consumers — though economists expect that to be a less reliable source of disinflation going forward.

So-called core goods prices, which exclude food and energy commodities, were flat in May after declining in the prior two months. Prices of used cars rose by the most this year, while prescription drugs were up by the most since January 2023.

A separate report Wednesday, combining the inflation data with figures on wages published last week, showed real earnings growth increased 0.8 per cent from a year ago, the most in three months.