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May CPI Forecasts Show Inflation Softening Overall as Gas Prices Ease

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Forecasts for the May Consumer Price Index report show overall inflation easing thanks to falling gas prices, while core inflation (which excludes volatile food and energy prices) remains elevated.

May's CPI data will be released on the heels of an unexpectedly strong employment report and during the Federal Reserve's June meeting. Market watchers don't anticipate any change in interest rates. Still, the release comes at a critical juncture for the Fed, which is attempting to thread the needle by keeping interest rates restrictive enough to curb inflation without letting the economy either overheat or slow down too much.

Three consecutive months of hot inflation data at the beginning of the year shook investor confidence, but a benign April report helped ease their worries.

May CPI Report Highlights

José Torres, senior economist at Interactive Brokers, will watch to see if lower gas prices helped improve the overall inflation number. "Gasoline and oil prices really ticked down hard in May," he explains. "That's a favorable development for headline inflation." He expects the overall inflation number to rise 0.12%—much lower than last month—and core inflation to rise 0.32%.

Core Goods Prices to Rise, Shelter Inflation to Remain Sticky

While much of the improvement in inflation over the past year has come thanks to declining goods prices, analysts at Bank of America expect these prices in the core category to tick up in May, thanks to rising prices for used cars and clothing. But they don't see a trend. "We think the increase in used cars will be temporary since wholesale prices have continued to fall and new car supply is recovering," they wrote last week.

Some minor improvement in the core services category is also possible. Bank of America and Goldman Sachs analysts expect car insurance prices to decelerate in the coming months. Goldman's forecast of 0.25% core inflation and 0.11% overall inflation also reflects a softening in airline prices and lower prices from online shopping data.

Shelter costs—which have remained a primary driver of inflation for months—will likely stay elevated. "The traditional problematic areas will remain: shelter, healthcare, transportation services, [and] food away from home," Torres says. "Those are going to be sticky."

How Will the Fed See May CPI Data?

If May's data comes in as expected, it could give the central bank more confidence that interest rates have been restrictive enough to accomplish their goal. "We anticipate the report to provide additional evidence that inflation is returning to a cooling trend after flaring up in Q1," Wells Fargo economists wrote Friday.

Economists expect that the overall CPI rose 0.1% on a monthly basis in May, according to FactSet's consensus estimates, compared with a 0.3% increase the previous month. That would hold the overall annual inflation rate steady at 3.4%. Meanwhile, economists expect core CPI to rise 0.3% for May, the same as in April. That would bring annual core inflation to 3.5% from 3.6% in April.

Bank of America analysts characterized today's inflation landscape as "stable" but still too high for the Fed's comfort. "A report in line with our expectations would not be concerning, but it would not be encouraging for the Fed either," they wrote.

When Will the Fed Cut Rates?

The Fed is almost universally anticipated to keep interest rates at the current range of 5.25%-5.50% at its Wednesday meeting.

"We expect Chair Powell will express confidence that the economy is still on a path toward a sustained recovery with inflation heading toward two percent—and that they can remain patient as they expect to gradually gain more confidence in that outlook," JPMorgan analysts led by Michael Feroli wrote Friday.

If inflation continues to soften, analysts say rate cuts are possible closer to the end of 2024. Morningstar forecasts two cuts this year, while Bank of America analysts expect just one. "We feel it is unlikely that inflation data will soften enough over the coming months to enable the Fed to cut before December," they wrote. Market participants are somewhere in the middle. As of Monday, bond futures markets were projecting a roughly 40% chance of one 0.25% rate cut by December and a roughly 36% chance of two cuts, according to the CME FedWatch tool.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.

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