Falling Energy Prices Spark Hopes for Fed Rate Cuts

US inflation came in below expectations in a boost for investors hoping that the US Federal Reserve might be able to start cutting interest rates in a matter of months.

Figures from the Bureau of Labor Statistics showed that prices did not increase in the month for the first time since last June. Economists had expected to see a 0.1 percent increase.

This meant the annual rate of inflation eased to 3.3 percent, slightly below the 3.4 percent expected by markets.

Energy prices were the largest downward drag, falling 2.0 percent. Shelter costs, which cover housing, rose 0.4 percent for the fourth consecutive month.

Core inflation-which excludes volatile components such as food and energy-increased 0.2 percent in May, slightly undershooting expectations and bringing the annual rate down to 3.4 percent.

"This fall provides evidence that monetary policy is having its intended effect and brings the economy one step closer to the Fed's target of two percent," Richard Flynn, managing director at Charles Schwab UK, said.

The pound leapt higher on the news and was trading around 0.80 percent higher against the dollar at $1.2840. London markets also received a slight bump.

May's figures will take on extra significance as investors look forward to the US Federal Reserve's latest interest rate decision later today.

Markets think interest rates will be left on hold for the seventh consecutive meeting, but the more important question is how the Fed's so-called 'dot-plot' projections have changed.

These forecasts show how policymakers expect economic conditions to develop and will give investors some clues about when rate-setters might be willing to cut interest rates.

Throughout much of this year, inflation has come in ahead of expectations forcing markets to reassess when the rate-cutting cycle will begin.

At its last meeting, the Fed acknowledged that there has been "a lack of further progress" on getting inflation back to target.

Fresh figures out last week also showed that the economy added significantly more jobs than expected in April, suggesting the economy is still running very hot.

Markets do not expect rate cuts to begin in the summer but could envisage a September cut. According to CME's Fedwatch, before today's inflation figures were released, there was a 50 percent chance that interest rates would be cut in September.

This increased to around 60 percent following today's inflation release. Kyle Chapman, an FX markets analyst at Ballinger Group, said the figures would be too late to change the 'dot-plot' graphs.

However, Chapman said markets should "certainly expect" the figures to be reflected in Jerome Powell's press conference. Chapman suggested Powell might be "particularly chirpy".

The Fed's latest decision comes a week after the European Central Bank cut rates for the first time in five years, starting the firing gun on interest rate cuts among major central banks.

By CityAM

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