US inflation slowed more sharply than expected in June, providing temporary relief for households, businesses and financial markets while reducing the immediate likelihood of another interest-rate rise by the Federal Reserve.

The US Consumer Price Index fell by 0.4% between May and June, its largest monthly decline since April 2020. Annual inflation dropped from 4.2% to 3.5%, below the 3.8% rate anticipated by economists. Underlying inflation also improved, although renewed increases in oil prices mean that June’s figures may not mark the beginning of a sustained decline.

The figures prompted investors to reduce their expectations that the Federal Reserve would raise interest rates at its meeting later this month. However, inflation remains above the central bank’s 2% objective, and policymakers continue to warn that another rise may ultimately be required.

Energy prices drive the fall in headline inflation

Falling energy costs were the principal reason for the improvement.

The US energy price index declined by 5.7% in June, reversing part of the substantial increases recorded earlier in the year. Gasoline prices fell by 9.7% during the month, while fuel oil declined by 9.2% and electricity prices decreased by 1%.

The decline followed a temporary easing of hostilities between the United States and Iran, which reduced concerns about oil supplies and caused wholesale energy prices to fall.

However, the fall in June should be considered in the context of the substantial increases recorded during the previous months. Despite becoming cheaper during June, gasoline remained 26.7% more expensive than a year earlier. Fuel oil prices were 42.9% higher and the overall energy index had increased by 15.7% over the previous 12 months.

The latest inflation figures therefore represent a reduction in the rate of price growth rather than a return to inexpensive energy.

Renewed fighting in the Gulf has also pushed oil and gasoline prices higher again during July. The US national average gasoline price had risen to approximately $3.86 a gallon by Tuesday, compared with $3.79 a week earlier. This means that part of June’s improvement may be reversed when July’s inflation figures are published.

Core inflation also shows improvement

More encouragingly for the Federal Reserve, inflation excluding food and energy also slowed.

Core consumer-price inflation fell from an annual rate of 2.9% in May to 2.6% in June. Core prices were unchanged compared with the previous month, following a 0.2% increase during May.

This suggests that the decline was not entirely the result of cheaper gasoline.

Several components that had previously placed pressure on household budgets became cheaper. Motor-vehicle insurance prices fell by 2% during June, following a 1.7% decline in May. Communication costs decreased by 1.5%, clothing prices fell by 0.6% and used car and truck prices declined by 0.2%. Medical-care prices also edged lower.

Shelter costs, which include rents and the estimated rental value of owner-occupied homes, increased by only 0.1%. This was their smallest monthly rise since January 2021 and may indicate that the prolonged period of rapid housing-cost inflation is beginning to moderate.

Service-sector inflation excluding energy was unchanged during June, although it remained 3.2% higher than a year earlier. Shelter costs were 3.3% higher and transportation services were 3.4% more expensive over the same period.

The figures provide evidence that underlying inflation is becoming less broad-based. Nevertheless, annual core inflation remains above the Federal Reserve’s target, while some household services continue to rise faster than policymakers would prefer.

Food prices continue to rise

The improvement in the headline figures will not necessarily be immediately recognised by American households, particularly those spending a large proportion of their income on food.

Food prices increased by 0.2% during June and were 3% higher than a year earlier. Grocery prices rose by 0.2% during the month, while the cost of eating in restaurants and other food-service establishments also increased by 0.2%.

Egg prices increased by 4.3% during June and dairy products became 1.2% more expensive. Cereals and bakery products rose by 0.3%.

There were reductions in some categories. Coffee prices fell by 2%, non-alcoholic beverages declined by 1.5%, and fruit and vegetable prices decreased by 0.2%. However, fruit and vegetables remained 5.3% more expensive than a year earlier.

These differences illustrate why a lower national inflation rate does not automatically produce a similar improvement for every household.

The Consumer Price Index measures the average change in the price of a broad basket of goods and services. Individual consumers experience inflation differently depending upon how much they spend on housing, food, energy, transport, healthcare and other items.

June’s figures reverse the earlier inflation surge

The sharp slowdown follows several months in which inflation had accelerated.

Annual US inflation increased from 2.4% in February to 4.2% in May, partly because of higher oil and transportation costs caused by the conflict with Iran. May’s figure was the highest annual rate recorded since April 2023.

June’s figures provide reassurance that the earlier increase had not yet developed into a wider and more persistent inflationary cycle.

There is also tentative evidence that the effect of earlier US tariffs on consumer prices may be fading. Core goods prices declined by 0.1% for the second consecutive month. New vehicle prices were unchanged, used vehicle prices fell and clothing became cheaper.

This could indicate that retailers and manufacturers have absorbed part of the higher import costs through their margins, adjusted supply chains or completed the initial round of price increases associated with tariffs.

However, the extent of tariff-related inflation remains difficult to separate from exchange-rate movements, changing consumer demand and fluctuations in commodity and transport costs.

Federal Reserve expected to leave rates unchanged in July

Financial markets responded positively to the report.

US share prices rose, government bond yields fell and the dollar weakened as investors concluded that the Federal Reserve was less likely to increase interest rates at its meeting on 28 and 29 July.

Before the inflation figures were released, financial markets assigned an approximately 35% probability to a quarter-point interest-rate rise in July. That probability subsequently fell to around 10%.

Expectations of an increase at the September meeting also declined, although markets continued to assign a probability of approximately 60% to a rise by that stage. These market-implied probabilities can change rapidly as new economic and geopolitical information becomes available.

The Federal Reserve’s target interest-rate range currently stands at between 3.5% and 3.75%. Chairman Kevin Warsh told Congress that policymakers had “no tolerance” for persistently elevated inflation and remained committed to restoring price stability.

Fed Governor Christopher Waller has similarly indicated that several months of softer inflation would be required before he became comfortable ruling out another rate rise. His comments reflect the risk that policymakers could react too quickly to a single favourable report.

The Federal Reserve watches a different inflation measure

Although the Consumer Price Index receives considerable public attention, the Federal Reserve formally measures its 2% inflation objective using the Personal Consumption Expenditures price index.

The two measures use different methods and place different weights upon goods, services and housing costs.

Following the CPI report, economists estimated that annual core PCE inflation probably remained at approximately 3.3% in June, compared with 3.4% in May. This would still be materially above the Federal Reserve’s target.

The central bank must also consider economic growth and employment.

US unemployment stood at 4.2% in June, while payroll employment increased by a provisional 57,000. The labour market has therefore weakened compared with the rapid growth recorded during the post-pandemic recovery, but has not deteriorated sufficiently to make inflation the Federal Reserve’s only concern.

Raising interest rates could help restrain consumer demand and prevent inflation from becoming embedded in wages and prices. However, it would also increase borrowing costs for households and businesses and could place further pressure on employment and investment.

Renewed conflict creates an uncertain outlook

The principal risk is that June’s energy-price decline proves temporary.

The ceasefire that helped reduce oil prices has since collapsed, while renewed attacks upon commercial shipping around the Strait of Hormuz have revived concerns about global energy supplies. Approximately one-fifth of the world’s crude oil supply normally passes through the waterway.

Higher oil prices affect the economy through more than the cost of filling a vehicle.

They increase the cost of aviation, road transport, shipping, plastics, chemicals, agriculture and industrial production. Businesses may initially absorb these additional costs, but sustained increases are eventually likely to be passed to consumers.

Airlines have already indicated that higher fuel costs are contributing to elevated ticket prices. US airline fares were 26.5% higher in June than a year earlier, despite broader evidence that service inflation was slowing.

The Federal Reserve’s June meeting minutes showed that officials had become increasingly concerned about inflation resulting from higher energy and other input costs. Although its staff expected headline inflation to decline during the second half of 2026, core inflation was projected to change relatively little over the remainder of the year.

What the figures mean for American businesses

For US companies, the report provides a degree of relief but does not remove the need for caution.

Businesses dependent upon consumer spending may benefit if slower inflation improves household confidence and disposable income. Lower bond yields could also reduce the cost of raising finance, particularly for larger companies borrowing in capital markets.

Retailers may face less pressure to increase prices if energy, insurance and imported-goods costs stabilise. Companies that have struggled to pass higher costs to customers could begin to rebuild margins.

However, energy-intensive industries remain exposed to renewed increases in oil and gas prices. Transport operators, airlines, manufacturers and logistics companies may need to maintain contingency plans for further cost volatility.

Businesses should also avoid assuming that lower inflation will lead quickly to lower interest rates. The immediate debate in the United States concerns whether the Federal Reserve will raise rates again, rather than when it will begin a substantial programme of reductions.

Borrowing costs are therefore likely to remain comparatively high, even if July’s anticipated increase is postponed.

Implications for UK businesses

The performance of the US economy has significant consequences for the United Kingdom.

Trade in goods and services between the two countries totalled approximately £331.5 billion during the four quarters ending in December 2025. UK exports to the United States were worth £202.7 billion, of which £143 billion related to services.

A continued expansion of the US economy would support demand for British financial, professional, technology and business services. British manufacturers exporting pharmaceuticals, machinery, vehicles and specialist products also depend upon American corporate and consumer demand.

The immediate currency effect may be mixed.

Reduced expectations of a US interest-rate rise caused the dollar to weaken. A stronger pound against the dollar lowers the sterling cost of US imports, including some commodities, technology products and business services. However, it also reduces the sterling value of revenue earned by British companies in America and can make UK exports more expensive for US customers.

Lower US bond yields can also influence global financing conditions. International investors compare returns across countries, meaning that changes in American interest-rate expectations can affect UK gilt yields, company borrowing costs and equity valuations.

The Bank of England will nevertheless base its own decisions primarily upon British inflation, wages and economic activity. A softer US inflation report does not guarantee lower UK interest rates, particularly while global energy prices remain volatile.

A welcome report, but not yet a decisive turning point

June’s figures are clearly more favourable than expected.

Headline inflation slowed substantially, core prices were unchanged during the month and shelter inflation recorded its smallest increase for more than five years. These developments have reduced the immediate pressure upon the Federal Reserve to raise interest rates.

However, the improvement was heavily influenced by a sharp and potentially temporary fall in energy prices.

Annual inflation remains at 3.5%, core PCE inflation is believed to remain above 3%, and renewed conflict has already caused oil and gasoline prices to rise again. Food, housing and several important services also continue to become more expensive.

The Federal Reserve is therefore unlikely to declare victory on the basis of a single report.

For businesses, June’s inflation figures reduce the risk of an immediate interest-rate increase and suggest that underlying price pressures may be easing. The more important question is whether this improvement continues through July and August, despite renewed pressure from energy markets.

Until that becomes clearer, the US economy remains caught between encouraging evidence of disinflation and the continuing risk of another externally driven price shock.

Photo by Julia Avamotive: https://www.pexels.com/photo/a-person-buying-from-a-grocery-6389973/