Inflation Drops to 3.5% in Welcome Sign for Mortgage Rates

Falling energy prices drove down inflation in June, offering the Federal Reserve's policymakers and would-be homebuyers a welcome reprieve after May's dramatic surge.

Beating economists' expectations, overall prices increased by 3.5% in the 12 months through June, retreating from the previous month's three-year-high of 4.2%, according to the U.S. Labor Department's Consumer Price Index (CPI) data released Tuesday.

Total prices actually fell 0.4% in June compared to May, driven by a sharp decline in energy prices, as a ceasefire between the U.S. and Iran sent global oil prices lower. Hostilities have resumed in recent days, potentially undoing that trend.

The energy index plunged 5.7% in June—the largest one-month drop in more than six years—after rising 3.9% in May, more than offsetting increases in other indexes, including the index for food, which ticked up 0.2% over the month and 3% over the last year.

Gasoline of all types increased 26.7% in the 12 months ending in June, but fell 9.7% from May.

Meanwhile, the price of groceries edged up 0.2% month over month and 2.7% over the year, with the egg index seeing a 4.3% jump.

Core inflation, which strips out volatile food and energy costs, was flat month over month and cooled to an annual rate of 2.6%, down from 2.9% in May.

June saw housing costs ticked up by just 0.1% from May, representing the smallest monthly change reported for the shelter index since January 2021.

What this means for the Fed and consumers

Realtor.com® senior economist Jake Krimmel says the markets' immediate reaction to the June CPI print suggests that the Federal Open Market Committee (FOMC) will hit the pause button on rates again this month.

The 10-year Treasury yield, which mortgage rates closely track, fell about 6 basis points on release, and the CME FedWatch Tool, which had priced the odds of a July 29 rate hike at 47% Monday afternoon, saw those odds plummet to 17% minutes after the CPI release.

"Still, one soft reading does not settle the inflation question, especially with the Fed’s preferred inflation gauge (PCE) still running hot," warns Krimmel. "Two data points from May to June don't constitute a trend for the FOMC."

Federal Reserve Governor Christopher Waller said yesterday that policymakers would need to see a sustained series of cooler readings, especially in core, before concluding elevated inflation is truly behind us. 

For consumers and homebuyers, Krimmel says falling inflation is good news because it removes one source of upward pressure on mortgage rates, which increased 6 basis points to 6.49% last week and have hovered around 6.5% for nearly two months.

"Today's data, combined with the drop in Treasury yields, may point toward some relief rather than the renewed instability the market had been bracing for," notes the economist. "That matters heading into the traditionally slower but still-active late-summer buying season." 

However, Krimmel reminds that Tuesday's CPI readout is just a single snapshot, and economic conditions tend to shift quickly.

"With the Middle East ceasefire fragile and energy prices historically volatile, the durability of today's relief will depend on whether core inflation keeps cooling in the months ahead, not just this one," he adds.