The annual pace of US inflation eased last month to its lowest level in more than two years, but lingering price gains will keep pressure on the Federal Reserve to consider additional interest rate increases.

The consumer price index climbed 4 per cent in May compared with a year earlier, a significant step down from the 4.9 per cent annual jump registered in April and marking the slowest increase since March 2021. Inflation has also slowed sharply from its peak of 9.1 per cent last June.

Consumer prices edged up just 0.1 per cent on a monthly basis in May, data released by the Bureau of Labor Statistics on Tuesday showed.

Once volatile items such as food and energy are stripped out, however, “core” CPI rose another 0.4 per cent in May — matching April’s increase. Compared with the same time last year, core prices are up 5.3 per cent.

Following the data, the two-year Treasury yield, which moves with interest rate expectations, dipped 0.006 percentage points to 4.586 per cent. US stocks advanced, with the S&P 500 and Nasdaq Composite both up about 0.5 per cent. 

The latest read on inflation comes just before the Fed begins its two-day policy meeting. The US central bank is widely expected to forgo an interest rate increase this week after 10 consecutive rises since March 2022, but will keep the door open to further tightening this year if warranted by the data.

“They have more work to do,” said Marc Giannoni, who formerly worked at the Fed’s regional banks in Dallas and New York. He expects the central bank to deliver at least two further quarter-point rate rises this year, which he says are necessary to tame the stickiest of price pressures.

“We still have this loop between the tightness in the labour market, income generation and [that] then fuelling consumption that keeps the labour market tight,” said Giannoni, who is now chief US economist at Barclays. “The Fed is trying to slow that down and to break that cycle.”

Some officials have signalled they do not think the current level of the federal funds rate, which hovers between 5 and 5.25 per cent, is high enough to damp demand to the degree necessary to tame one of the worst inflationary episodes to hobble the central bank in decades.

Consumer prices are down sharply from their peak of 9.1 per cent last June but inflation remains well above levels the Fed is looking for.

US president Joe Biden on Tuesday framed the report as “good news”, adding it “shows continued progress tackling inflation at the same time that unemployment remains at historic lows.”

The deceleration in last month’s CPI was driven by a 3.6 per cent drop in energy prices for the month and a modest 0.2 per cent increase in food prices.

Meanwhile, the so-called “shelter” index, which tracks housing-related costs, rose 0.6 per cent in May, making it one of the biggest drivers of the monthly increase in core prices, according to the BLS data. The index was up 8 per cent from a year ago.

Economists have been waiting for housing inflation to ease, reflecting last year’s sharp drop in rents and home prices, which takes time to show up in the data. In a worrying sign, however, home prices in some parts of the country have begun to level off or increase.

Meanwhile, a closely watched metric of underlying inflation — so-called “core services ex-housing” — edged up slightly to 0.24 per cent from 0.11 per cent in April, according to calculations by BMO Capital Markets.

Kathy Bostjancic, chief economist at Nationwide, described the report as “encouraging” but cautioned that there was a high degree of uncertainty about the economic outlook. She still expected the US to tip into a recession but said the timing had been delayed given the recent strength in the incoming economic data.

Fresh projections from individual officials about the fed funds rate, inflation, growth and unemployment are set to be released on Wednesday alongside the rate decision, and it is widely expected that policymakers will indicate that at least one additional quarter-point rate rise this year will be necessary.

Economists recently polled by the Financial Times believe the Fed will eventually have to lift the benchmark rate to between 5.5 per cent to 6 per cent. That suggests at least two more quarter-point rate rises this year.

Additional reporting by Kate Duguid in New York