US consumer prices unexpectedly fall; core inflation benign

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The government data released Wednesday came out just hours before the Federal Reserve is widely expected to increase interest rates when concludes its two-day monetary policy meeting, despite weak inflation and tepid wage growth. On a year-on-year basis, shelter costs rose 3.3 percent and have been a key driver lifting services inflation in the last two years. Policymakers continued to expect the economy to expand at a "moderate" pace and labor market conditions to "strengthen somewhat" further.

Consumer spending accounts for more than two-thirds of the U.S. economy and last month's weak core retail sales reading could temper expectations for a sharp acceleration in economic growth in the second quarter.

U.S. consumer prices fell more than expected in May, according to the Department of Labor's monthly consumer price index (CPI).

Last month, rental costs increased 0.3 percent, matching April's gain.

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The year-on-year gain in the CPI in May was still larger than the 1.6 per cent average annual increase over the past 10 years.

Economists expected the CPI to be unchanged, with core prices rising 0.2%. The core CPI increased 1.7 percent year-on-year, the smallest rise since May 2015, after advancing 1.9 percent in April. The Fed's preferred measure of inflation, tied to consumer spending, has been below 2 percent for five years and in recent months slipped back a bit. By contrast, "doves" favor the direction taken under Chair Janet Yellen, favoring relatively low rates to maximize employment.

The Fed hiked its benchmark overnight interest rate by 25 basis points to range of 1.00 percent to 1.25 percent, and said it would start reducing its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities this year. The index, which tracks the greenback against the currencies of major USA trade counterparts, was above the 97 level before the data release.

It was the second drop in the CPI in three months. Among the major areas of weakness, electronics store sales fell 2.8% vs. April and are now down 0.2% year to date. Receipts at service stations dropped 2.4 percent, the largest decline since February 2016.

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The Atlanta Fed is forecasting the economy growing at a 3.0 percent annualized rate in the second quarter, but this estimate could be trimmed following the weak core retail sales. Gasoline prices also dropped 6.4 percent.

While the markets do not appear to be reacting to the bad attack in Alexandria, it does appear to be reacting modestly to this morning's disappointing May retail sales and Consumer Price Index (CPI) report.

May's surprise sluggishness in consumer spending, which accounts for more than two-thirds of the USA economy, could worry Federal Reserve officials who have previously attributed the slowdown in domestic demand to transitory factors. Monthly retail sales surprised to the downside as well, marking a contraction during the month.

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