Cooler Inflation Bolsters Argument for Fed Rate Pause

Federal Reserve officials received an encouraging inflation report on Tuesday as price increases continued their monthslong slowdown in May, news that could give policymakers comfort in pausing interest rate increases at their meeting this week.

The Consumer Price Index climbed 4 percent in the year through May, slightly less than the 4.1 percent that economists had expected and the slowest pace in more than two years. That was notably cooler than in April, when it climbed 4.9 percent.

Inflation is down sharply from a peak of about 9 percent last summer, though it remains about twice as fast as was normal before the onset of the coronavirus pandemic in 2020.

The fresh data offer the latest evidence that the Fed’s push to control rapid price increases is beginning to work. Officials have raised rates at every one of their meetings starting from March 2022, making it more expensive to borrow money in hopes of slowing consumer demand, tamping down a strong labor market and ultimately cooling rapid inflation. Now that they have made 10 straight rate increases, many officials have suggested in recent weeks that they could soon take a pause to assess how those adjustments are working.

Investors have been betting that Fed officials will leave rates unchanged at their meeting this week — and their conviction that policymakers will skip a move this meeting deepened after Tuesday’s report, helping to extend the recent rally in stocks. Yet the details in the data underscored that wrestling inflation the whole way back to normal could prove challenging, so investors continued to expect that Fed officials will raise rates again in July.

“It’s a fine report,” said Sarah Watt House, senior economist at Wells Fargo. “But I still think it keeps the Fed on edge.”

Inflation is proving stubborn in a few key categories. Fed officials closely monitor month-to-month changes in prices, particularly for a so-called core index that strips out volatile food and fuel costs to get a sense of the recent trends in inflation. That figure continued to pick up at an unusually quick pace in May, slightly above what economists had expected.

Several service categories continued to climb quickly in price, from car insurance to moving expenses and hotel rates. Price increases for goods excluding motor vehicles also remained positive, instead of subtracting from inflation as some economists have been expecting.

“It’s possible firms have gotten used to raising prices,” said Laura Rosner-Warburton, a senior economist at MacroPolicy Perspectives.

But while the data offered reasons for continued vigilance, taken as a whole, they suggested that the inflation that has been plaguing consumers and bedeviling the Fed for two years is also meaningfully slowing.

Costs for some services are beginning to climb more slowly or even decline. Rental inflation has long been expected to cool off, and that is beginning to happen. Airfares came down sharply last month, and a range of recreation-related purchases — from movie tickets to pet care — moderated in price.

A cooling economy and a gradually weakening job market could help to weigh down inflation in the months to come. Fed officials try to keep inflation at 2 percent on average over time, using a different but related measure — the Personal Consumption Expenditures index. The Consumer Price Index measure comes out a few weeks earlier and contains data that feeds into the Fed’s preferred measure, which is why investors watch it so closely for a signal of where inflation is heading.

The central bank’s two-day meeting started Tuesday and will conclude Wednesday afternoon, when officials are scheduled to release their interest rate decision. That announcement will be accompanied by a new set of economic projections. Jerome H. Powell, the Fed chair, is scheduled to give a news conference to explain both the decision and the outlook.

Investors are likely to follow his remarks even more carefully than usual, because the complicated nature of today’s economy makes it difficult to guess where policy is headed.

Officials are trying to strike a delicate balance: They want to slow the economy enough to make sure that inflation is fully stamped out, but without hitting the brakes so hard that growth grinds to a halt and workers unnecessarily lose jobs.

Calibrating policy is difficult. Changes in interest rates take months, or even years, to have their full effect, so the Fed’s rate increases since early 2022 — the steepest since the 1980s — are still playing out.

And recent economic data have offered a mixed picture. Hiring has been surprisingly resilient, and consumer spending has held up. But surveys of manufacturers suggest that a marked slowdown is underway, and jobless claims have risen recently. The Fed is also still trying to gauge the fallout from recent bank turmoil, which could slow the economy by prodding lenders to be more cautious.

“They are going to have to walk a very fine line,” Ms. Watt House said of the Fed, explaining that policymakers will need to acknowledge recent progress — and that inflation remains too rapid. “They are going to have to communicate that they know they haven’t won the battle.”