Inflation cools to 3.5% as consumer prices post biggest monthly drop since 2020
U.S. inflation cooled more than expected in June, offering consumers and financial markets welcome relief after several months of accelerating price pressures. The latest Consumer Price Index (CPI) data from the Bureau of Labor Statistics showed annual inflation slowed to 3.5% from 4.2% in May, well below economists’ expectations for a 3.8% reading.
The report also marked the first monthly decline in consumer prices since 2020, driven largely by falling energy costs after oil prices retreated during a temporary easing of tensions in the Middle East. While investors welcomed the softer inflation data, economists cautioned that the report reflects June conditions and may not capture the renewed jump in oil prices seen in July.
Inflation slowed more than economists expected. The Consumer Price Index rose 3.5% over the 12 months ending in June, down from 4.2% in May and below the 3.8% consensus forecast.
On a monthly basis, CPI fell 0.4% after increasing 0.5% in May. Economists had expected only a 0.1% decline, making June’s drop the largest one-month decrease since April 2020 and the first monthly decline since May 2020.
The Bureau of Labor Statistics said the all-items index increased 3.5% over the past year, while the seasonally adjusted CPI-U declined 0.4% during June.
The latest reading also marked the lowest annual inflation rate since March 2026.
Falling energy prices drove most of the improvement
Energy prices accounted for much of June’s decline in inflation after oil prices retreated during a temporary ceasefire in the Persian Gulf.
The BLS reported the energy index fell 5.7% during June after posting gains in previous months, including increases of 10.9% in March, 3.8% in April and 3.9% in May. The decline in energy prices more than offset continued increases in categories such as shelter and food.
On an annual basis, however, energy prices remained elevated, rising 15.7% compared with a year earlier, although that was down from May’s 23.5% increase. Gasoline prices were also still 26.7% higher than a year ago, but that represented a notable slowdown from the previous month’s 40.5% annual increase.
Economists said that the deceleration in headline inflation was largely due to the dissipating effects of the oil price shock. Still, the new report is backward-looking, so it doesn’t capture the recent uptick in gas prices after they fell in June.
Core inflation also came in below expectations
The report showed underlying inflation pressures eased as well.
Core CPI, which excludes food and energy, was unchanged during June after economists had expected a 0.2% monthly increase.
On an annual basis, core inflation slowed to 2.6%, down from 2.9% in May and below forecasts of 2.8%.
Shelter inflation also moderated slightly, with the shelter index rising 3.3% from a year earlier compared with 3.4% in May.
The market’s initial reaction reflected a more dovish outlook, with Treasury yields declining and expectations growing that the Fed could maintain or eventually ease monetary policy if inflation continues to moderate. Analysts noted that lower yields could support equities, gold, and other interest rate-sensitive assets, but they also warned that headline inflation remains above the Fed’s target and that rebounding oil prices could quickly reignite inflationary pressures, making it too early to conclude that the inflation fight is over.
Real wages stopped declining
June’s inflation report also brought some relief for workers.
Annual inflation matched the Bureau of Labor Statistics’ previously reported 3.5% increase in nominal wages, ending a stretch during which inflation had been outpacing wage growth and eroding purchasing power.
While wage gains no longer lagged inflation in June, economists note that sustained moderation in consumer prices would be needed for workers to see stronger real income growth over time.
Financial markets reacted positively after the inflation data came in cooler than expected.
U.S. Treasury yields declined Tuesday morning as investors increased purchases of government bonds following the report. Lower-than-expected inflation also boosted expectations that the Federal Reserve will avoid raising interest rates at its upcoming policy meeting.
According to CME FedWatch, markets priced in an 83% probability that the Fed would leave interest rates unchanged at the end of July, up from roughly 60% before the CPI release.
Economists said the softer-than-expected inflation report is likely to strengthen expectations that the Federal Reserve will leave interest rates unchanged at its upcoming meeting while reducing the odds of another rate hike in the near term. However, they cautioned that Fed Chair Kevin Warsh has consistently struck a hawkish tone in recent public remarks, suggesting policymakers may remain cautious about declaring victory over inflation.
The June report may already be outdated
Despite the encouraging headline figures, several economists cautioned that June’s inflation report reflects conditions that have since changed.
Following the expiration of the mid-June ceasefire and renewed geopolitical tensions, oil prices have climbed sharply again. Brent crude has moved above $86 per barrel, raising concerns that July inflation could look significantly different.
Economists cautioned that the June CPI report largely reflects past conditions rather than the current inflation environment. They noted that the decline in inflation was driven primarily by lower oil and gasoline prices during June, while recent increases in energy prices following renewed geopolitical tensions may not appear in the CPI data until the July report, potentially leading to higher inflation readings next month.
Higher oil prices could complicate the Fed’s outlook. The June report provided welcome evidence that inflation can cool quickly when energy prices retreat, but policymakers may remain cautious.
At its June meeting, the Federal Reserve adopted a more hawkish tone after several months of stronger inflation readings, raising its inflation projections and signaling interest rates could remain higher for longer.
While some Fed officials have pointed to moderating shelter inflation as a positive sign, others remain concerned that inflation could accelerate again if higher energy costs spread throughout the broader economy.
Economists noted that energy prices were the primary driver behind June’s improvement. They warned that renewed geopolitical tensions could quickly reverse that progress.
White House highlights cooling inflation
The White House pointed to the report as evidence that inflationary pressures have eased more than many economists expected.
National Economic Council Director Kevin Hassett praised the latest figures. “It’s absolutely the best inflation report we’ve seen in about 6 years… If you look at the core, it’s all the way down, year-over-year, to 2.6%, which is just about where the Fed expects it to be.”
White House spokesperson Kush Desai also highlighted the reversal in energy prices.
“We had so many ‘experts’ and economists, many people in the media speculate that these disruptions that we saw… would be permanent; that oil prices would stay elevated for a very long time, would stay above $100… and we’ve seen the exact opposite of that.”
The White House Rapid Response account on X also emphasized that June’s CPI report exceeded economists’ expectations, posting:
“CPI fell by 0.4% in June, the largest decline since April 2020—and below the forecast of every single Bloomberg economist. Core inflation also came in better than expected, falling to 2.6% year-over-year.”
What investors will watch next
Although June delivered the strongest inflation report in months, investors and policymakers are now focused on whether the improvement will continue.
July’s inflation report, due next month, will include the impact of renewed increases in oil prices and could provide a clearer picture of whether June marked the beginning of a sustained cooling trend or simply a temporary pause driven by lower energy costs.
In the meantime, the Federal Reserve will weigh June’s inflation data alongside recent labor market figures when deciding whether to leave interest rates unchanged at its policy meeting later this month.
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John Dealbreuin came from a third world country to the US with only $1,000 not knowing anyone; guided by an immigrant dream. In 12 years, he achieved his retirement number.
He started Financial Freedom Countdown to help everyone think differently about their financial challenges and live their best lives. John resides in the San Francisco Bay Area enjoying nature trails and weight training.
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