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Inflation drops to lowest levels since March 2021 as economy cools

Wages are now rising faster than prices. The Federal Reserve isn’t ready to declare victory yet, because inflation isn’t consistently falling yet.

A shopper at a Target in Upper St. Clair, Pa., on Friday. (Gene J. Puskar/AP)
8 min

A year after inflation soared to the highest level in four decades, price increases are returning closer to normal levels, with families and businesses feeling the difference as wages rise faster than prices and policymakers debate how much more to slow the economy.

Government data released Wednesday showed a notable drop in inflation: Prices rose 3 percent in June compared with the year before, and 0.2 percent compared with May, the smallest 12-month increase since March 2021. That marked progress from the last inflation report, when prices rose 4 percent compared with the previous year.

There is a ways to go, especially on major categories such as rent. But encouraging signs were scattered throughout the Bureau of Labor Statistics report. Goods prices, from used cars to meats, saw declines compared with the month before. Categories that bulged over the past year, such as airfares and hotels, are also cooling off as demand settles back to normal.

Meanwhile, wages have grown faster than inflation for four straight months. Average hourly earnings rose 0.4 percent from May to June, outpacing inflation by 0.2 percent, according to a separate BLS report released Wednesday.

“This is the kind of mix you want to see, and want to see more of over the next few months. If it does, the pathway to 2 percent [inflation] for the Fed really does open up,” said Skanda Amarnath, executive director of Employ America, a liberal think tank pushing for the economy to run hot.

Wall Street rallied on the news. The S&P 500 index and tech-focused Nasdaq both ended Wednesday at their highest levels in more than a year. The Dow Jones Industrial Average was also up.

Housing costs were the main driver of inflation, as they have been for months. Rising rents and other shelter costs accounted for more than 70 percent of the June increase. Rent is up 8.3 percent compared with last year, and 0.5 percent compared with May. There are signs that rents on new leases are falling from pandemic highs, but it will be months before that shows up in the consumer price index, which lags behind real-time indicators.

Policymakers are especially fixated on a narrower measure of inflation known as “core inflation,” which strips out more volatile categories such as food and energy and can be especially hard to root out. That figure rose 0.2 percent in June compared to May, the smallest one-month increase in that index since August 2021 — and a hopeful sign that policymakers won’t have to be even more aggressive in fighting sticky price increases.

The latest data reflects a drastically different economic picture than in June 2022, when inflation spiked to 9.1 percent just months after Russia’s invasion of Ukraine sent energy prices soaring. This June’s inflation figure dropped so much partly because the yearly data compares against last year’s peak. The energy index, for example, which drove inflation for much of last summer, is now down 16.7 percent for the 12 months ending in June.

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Car insurance (1.7 percent), driven by high auto values and costs of repairs, and apparel (0.3 percent) rose compared with May’s prices. But there were a few bright spots: Airfares (8.1 percent), used cars and trucks (0.5 percent), and household furnishings and operations (0.1 percent) decreased in price compared with May.

Still, policymakers at the Federal Reserve aren’t ready to declare victory yet, especially because not every source of inflation is fading at the same time or with the same momentum. The Fed typically focuses most on a different inflation measure, but officials also pay attention to the BLS data.

Douglas Holtz-Eakin, president of the conservative American Action Forum, called the report a “classic mixed bag” and noted that while “we keep waiting for lower market rents to feed in, it hasn’t happened yet.” (Rents and housing costs make up about a third of the basket of goods used to calculate the consumer price index, and it will be difficult for overall inflation to return to normal levels if rent doesn’t cool off.)

The data could mislead policymakers if they put too much stock in energy price drops, Holtz-Eakin warned. Those costs feed into all kinds of goods and services — from transportation to hospitality. If energy costs were to rise again, the shift would lift prices on countless other categories.

“I think the Fed should remain vigilant,” Holtz-Eakin said, adding that the new inflation figures should cement two more rate hikes from the Fed, as the central bank is projecting by the end of the year.

The Biden administration, which has faced an uphill battle convincing Americans that it has a handle on inflation, cheered the news. In recent weeks, the president has touted his “Bidenomics” plan as a way to rebuild the economy for the middle class. In a statement Wednesday, Biden said the new report showed “Bidenomics in action.”

The figures offer “new and encouraging evidence that the U.S. economy is on the path to moderate inflation accompanied by a resilient jobs market,” Lael Brainard, director of the National Economic Council, told the Economic Club of New York.

Overall, inflation continues to move in the right direction without triggering unwanted economic consequences. Annual inflation has fallen for 12 straight months, and the United States now has the lowest readings among Group of Seven nations. Typically, when the Federal Reserve has to raise interest rates quickly, a recession follows and the job market suffers. That hasn’t happened.

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Instead, major banks are backing away from their bold predictions of a recession as the job market notches its 30th consecutive month of growth. The housing market, too, is showing signs of improvement as more homes come online. Prices for used cars are also expected to ease.

If those trends continue, it would mean the Federal Reserve has managed to hoist interest rates more than five percentage points without grinding the economy to a halt. At its most recent meeting in June, the Fed held rates steady for the first time in more than a year to give officials time to gather data on inflation, economic growth, jobs and wages. Rate hikes affect the economy with imprecise and unknown lags, and the risk is that any additional increases — the central bank is projecting two by the end of the year — will pile onto the braking effect that’s still coming. The repercussions of the spring banking crisis, too, are expected to slow the economy as banks pull back on lending, but no one knows how much.

“The data have come in [with] surprising strength, with inflation persistently printing too high,” San Francisco Fed President Mary Daly said at the Brookings Institution on Monday. “… So we’re balancing the risks to the economy going forward against the incoming information, which is about strength.”

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Policymakers pay close attention to how families and businesses respond or adapt to inflation. Price jumps can come from supply chain backlogs, worker shortages or energy price spikes. But they can also result from a psychological phenomenon: If people change their behavior now to account for inflation they fear is coming, trying to raise prices or buy up items ahead of the curve, that could make the Fed’s fight to stabilize the economy even harder.

In Durham, N.C., Scott Pearce has had to raise prices across the board at his business, For Garden’s Sake, because costs for machinery and supplies and hourly pay for entry-level workers have climbed. Although demand for his garden supply, landscaping and lawn maintenance services exploded during the pandemic, the frenzied rush is over.

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But Pearce is growing his company even in the face of so much uncertainty. He just filled a new sales role and got a truck delivered to expand fertilization services.

“I don’t want to be irresponsible,” Pearce said. “We could sit and be scared, but part of it is, in our area, people are still spending. … These are things they’re probably going to do no matter what. That’s how we’re handling it.”

Richard Farino’s outlook is grimmer. The owner of District Angling, a fly-fishing shop in Arlington, Va., said he hasn’t seen this kind of drop in customer activity since the Great Recession. He pointed to waning consumer confidence that leads people to spend less on activities and hobbies.

Farino is still contending with supply chain issues for the basics, such as the hairs and feathers needed to make and sell flies. He feels pressure to raise prices as manufacturers increase their own costs and worries about how much longer he can stay afloat.

“We are not a store for needs. We’re a store for wants,” Farino said. “And when people start feeling the pinch, they stop doing recreational stuff.”