Inflation in June grew by its slowest pace in more than two years, an encouraging sign that the Fed is on track to meet its benchmark target rate of 2%, new Labor Bureau data reveals.
The year-over-year inflation rate dropped from 4% in May to 3% in June, largely due to falling energy and transportation prices, according to the latest consumer price index report.
Perhaps most importantly, core inflation — a broad measure which excludes volatile food and energy prices — only grew by 0.2% month-over-month in June, after steadily rising by 0.4% or more for the past six months.
Core inflation is closely watched by the Fed as it's considered to be a more accurate measure of where inflation is headed.
The slowdown in core prices "puts inflation right back in the Fed sweet spot," Sarah House, a senior economist at Wells Fargo, tells CNBC Make It. "The June data shows that expectations for disinflation are not hopeless."
The drop brings year-over-year core inflation down from a rate of 5.6% in January to 4.8% in June.
However, considering that core inflation accounts for nearly 80% of all items in the CPI, that rate will need to drop much faster for the Fed to reach its target inflation rate of 2%. With core inflation's current rate of deceleration, Wells Fargo doesn't anticipate that inflation will go down to 2% until at least after 2024.
"There are reasons to be optimistic that the downward trend is more firmly in place, but I think the Fed is going to proceed pretty cautiously," says House.
"Getting to that 2% target — I think we're still a ways away," she says.
Why another Fed rate hike is likely
To cool inflation, the Fed has tried to discourage spending by making it more expensive to borrow money. To do this, they've raised their benchmark interest rate from near-zero in March 2022 to its current range of 5% to 5.25%.
However, the inflationary pressures from a resilient economy and job market remain a concern for the Fed, with the inflation rate still above its target of 2%.
For that reason, it's widely expected that the Fed will announce a 0.25 percentage point hike when the central bank meets on July 24 and 25. The probability of such an increase is 92.4% according to the CME FedWatch Tool, which measures rate hike probabilities.
That means borrowing would continue to get more expensive for consumers, with interest rates increasing slightly for credit cards, loans and auto financing.
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