U.S. inflation moderated modestly in July, though the annual pace of consumer price growth remained above the Federal Reserve's 2% target as policymakers weigh a potential interest rate hike at their next meeting.

The Bureau of Labor Statistics (BLS) reported on Wednesday that the consumer price index (CPI) — a broad gauge of prices for everyday goods including gasoline, groceries, and rent — rose 0.1% on a monthly basis and was up 3.4% from a year ago.

In Line With Expectations

The figures matched the estimates of economists polled by LSEG. The monthly reading follows a negative 0.4% print in June, while the annual figure came in slightly below the prior month's 3.5%.

Core prices, which strip out volatile food and energy costs to better capture underlying inflation trends, increased 0.2% month over month and were 2.5% higher year over year. The monthly figure marked a slight uptick after prices were flat in June, while the annual reading cooled from the previous month's 2.6%. Both headline and core measures remain above the Fed's 2% inflation objective, though they have eased substantially from the 9.1% year-over-year CPI peak reached in June 2022, the highest in roughly four decades.

Cost of Living Breakdown

Persistently high inflation has placed significant financial strain on most U.S. households in recent years, forcing consumers to pay more for everyday necessities such as food and rent. These price increases have been especially challenging for lower-income Americans, who tend to spend a larger share of their income on essentials and have less room to save.

Energy prices fell 1.5% on a monthly basis in July but remained 14.7% higher than a year ago, following a 5.7% decline in June.

Gasoline prices declined 2.9% in July but were still up 24.6% year over year. Electricity costs rose 0.1% monthly and were up 4.2% over the past year.

Food prices ticked up 0.1% from the prior month and were 3% higher than a year earlier. The food-at-home index declined 0.1% in July and was up 2.7% year over year, while the food-away-from-home index rose 0.3% and was 3.4% higher than last year.

The meats, poultry, and fish index declined 0.7% monthly but was up 4.5% annually, driven largely by beef and veal prices, which rose 9.4% over the past year despite a 0.8% decline in July. Egg prices fell 0.5% on the month and were down 25.7% year over year as poultry flocks continued to recover from a prior avian flu outbreak.

The fruits and vegetables index slipped 0.1% for the month and was up 5.1% year over year. Lettuce prices plunged 16.4% in July amid a Cyclospora outbreak but remained 7.5% higher than a year ago.

Housing costs rose 0.1% in July, a category the BLS said accounted for roughly two-thirds of the total monthly increase. The shelter index was up 3.2% year over year. Tenants' and household insurance prices edged down 0.1% in July but were 4.8% higher than a year ago.

Transportation services prices rose 0.3% in July and were 2.9% higher year over year. Airline fares climbed 2.2% on the month and were up 25.5% over the last year.

Expert Reaction

Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, said, "In-line inflation will keep the 'no need to hike rates' narrative that took hold after last week's jobs report intact."

"There will be another round of inflation data before the September FOMC meeting, so the storyline could still change. But unless those numbers tell a much different story, the Fed will likely still be in a position to leave rates unchanged next month," Zentner added.

Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, said, "With another round of inflation data due before the September FOMC meeting, it remains all to play for, but today's in-line report was a good start."

"Contained core inflation adds to the encouraging signs in last month's release of a moderation in underlying inflation, helping strengthen the case for a September hold," Rosner added.

Fed Rate Outlook

The July CPI report shifted expectations for the Federal Reserve's next policy meeting, with traders leaning more decisively toward a continued pause in rate adjustments. The Fed's challenge remains balancing its inflation fight against signs of a cooling labor market, which last week's jobs report brought into sharper focus.

According to the CME FedWatch tool, the market assigned a 61.9% probability that rates would remain at the current target range of 3.5% to 3.75%, up from 51.6% a day earlier. The odds of a 25-basis-point hike declined to 38.1% from 48.4% the previous day.

Looking ahead to year-end, the tool continued to price a single 25-basis-point rate hike as the most likely outcome, with 45% odds, compared with a 28.9% chance that rates stay at their current level and a 22.5% chance of two 25-basis-point hikes. The August CPI report, due before the September FOMC meeting, will be the final inflation readout policymakers receive before deciding their next move.

Market Response

The benchmark S&P 500 index rose more than 0.3% in early morning trading following the release of the July CPI report. The Nasdaq Composite gained approximately 0.6%, while the Dow Jones Industrial Average was little changed.