WASHINGTON (Reuters) - U.S. consumer prices were unexpectedly unchanged in May as cheaper gasoline and other goods offset higher costs for rental housing, but inflation likely remains too high for the Federal Reserve to start cutting interest rates before September.

The report from the Labor Department on Wednesday also showed underlying inflation pressures abated significantly last month, with the cost of motor vehicle insurance declining on a monthly basis for the first time since the fourth quarter of 2021.

The data prompted financial markets to boost the probability that the U.S. central bank would cut rates in September as well as in December, which had been diminished by news last week that job growth accelerated in May.

That optimism was shared by many economists who anticipated that Fed officials would keep two rate cuts for this year on the table later on Wednesday when they were expected to leave the central bank's benchmark overnight interest rate unchanged in the current 5.25%-5.50% range, where it has been since July.

"We don't know if the Fed has engineered a soft landing yet, but the economy is slowing and price pressures are sure to follow," said Christopher Rupkey, chief economist at FWDBONDS. "Inflation has turned the corner, and the first quarter blow-up is looking like it was an anomaly."

The unchanged reading in the consumer price index last month followed a 0.3% increase in April, the Labor Department's Bureau of Labor Statistics reported. It was the softest reading since July 2022. The CPI has been trending lower since posting solid readings in February and March.

Economists polled by Reuters had forecast the CPI would edge up 0.1% in May. Price pressures could continue moderating as major retailers, including Target, slash prices on goods ranging from food to diapers as they seek to lure inflation-weary consumers.

Higher inflation has soured Americans' perceptions of the economy, which has continued to expand despite the Fed's aggressive monetary policy tightening in 2022 and 2023, thanks to labor market resilience. Inflation has eroded U.S. President Joe Biden's popularity and could be among the factors that will determine the outcome of the Nov. 5 presidential election.

Biden welcomed the benign CPI report, saying it showed "progress on lowering inflation."

Last month, gasoline prices dropped 3.6% after increasing 2.8% in April. Food prices edged up 0.1% after being unchanged in April. Grocery store prices were unchanged amid a 1.3% drop in milk. There were also decreases in the prices of nonalcoholic beverages. Prices of fruits and vegetables were unchanged.

But meat, fish, eggs, cereals and bakery products cost slightly more relative to April. Rents increased 0.4%, matching April's rise. In the 12 months through May, the CPI advanced 3.3% after increasing 3.4% in April. Though the annual increase in consumer prices has slowed from a peak of 9.1% in June 2022, inflation continues to run above the Fed's 2% target.

The Fed has raised its policy rate by 525 basis points since March 2022. Following the CPI data, short-term interest rate futures implied about a 70% chance of a rate cut by September, compared with about a 54% probability earlier. Traders also added to bets on a second rate cut by December. Some economists are leaning towards a rate cut in December, but others are not sure the Fed will start its easing cycle this year.

Stocks on Wall Street were trading higher, with the S&P 500 and the Nasdaq Composite indexes hitting record highs. The dollar slipped against a basket of currencies. U.S. Treasury yields fell.

INFLATION SUBSIDING

Excluding the volatile food and energy components, the CPI climbed 0.2% in May. That was the smallest advance in the so-called CPI since last October and followed a 0.3% rise in April. The core CPI nudged up 0.16% before rounding, the smallest rise since August 2021.

Rents accounted for most of the increase in the core CPI. Owners' equivalent rent (OER), a measure of the amount homeowners would pay to rent or would earn from renting their property, gained 0.4% for a third straight month. But with market rents trending lower, a significant slowdown in CPI rent measures is expected this year.

"With most of the slowing in market rents yet to feed through to the CPI, and if the residual seasonality analysis is correct, then core inflation is poised to decelerate sharply in the second half of the year," said Conrad DeQuadros, senior economic advisor at Brean Capital.

Healthcare costs rose 0.5%, with prescription medication prices jumping 2.1%. The cost of hospital services increased 0.5%, but prices of physicians' services were unchanged. Education services cost more, but airline fares dropped 3.6% after falling 0.8% in April.

Motor vehicle insurance, one of the major drivers of core inflation, dropped 0.1%. It was the first and biggest monthly drop since October 2021. Motor vehicle insurance increased 20.3% on a year-on-year basis. Insurance premiums have surged, mostly reflecting the costs associated with repairs as a shortage of motor vehicles increased demand for used cars during the COVID-19 pandemic.

Overall, services increased 0.2% after advancing 0.4% in April. Excluding rents, services were unchanged last month.

Prices for used cars and trucks rebounded 0.6% after declining 1.4% in April. But new vehicle prices fell as did apparel, household furnishings and operations. Goods prices fell 0.4%. They were, however, unchanged excluding energy.

In the 12 months through May, the core CPI increased 3.4%. That was the smallest year-on-year gain since April 2021 and followed a 3.6% advance in April. The three-month annualized rate for the core CPI slipped to 3.3% from 4.1% in April.

Based on the CPI data, economists' estimates for May's core personal consumption expenditures price index were between a 1% and 2% rise. The core PCE price index, one of the inflation measures tracked by the Fed for monetary policy, gained 0.2% in April. Core inflation is forecast to have increased 2.6% on a year-on-year basis in May after gaining 2.8% in April.

"Restrictive monetary policy has more work to do," said Scott Anderson, chief U.S. economist at BMO Capital Markets.