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PCE price index flat in May; up 2.6% on year-on-year basis

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Core PCE edges up 0.1%; rises 2.6% on year-on-year basis

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Consumer spending gains 0.2%; personal income up 0.5%

By Lucia Mutikani

WASHINGTON, June 28 (Reuters) - U.S. monthly inflation

was unchanged in May as a modest increase in the cost of

services was offset by the largest drop in goods prices in six

months, drawing the Federal Reserve closer to start cutting

interest rates later this year.

The report from the Commerce Department on Friday also

showed consumer spending rose marginally last month. It raised

optimism that the U.S. central bank could engineer a

much-desired "soft landing" for the economy in which inflation

falls without triggering a recession and a sharp rise in

unemployment. Traders raised their bets for a Fed rate cut in

September.

"It helps the argument that inflation is looking

better-behaved, which may well open the door to interest rate

cuts later in the year," said James Knightley, chief

international economist at ING.

The flat reading in the personal consumption expenditures

(PCE) price index last month followed an unrevised 0.3% gain in

April, the Commerce Department's Bureau of Economic Analysis

said. Goods prices dropped 0.4%, the most since November. There

were big declines in prices of recreational goods and vehicles

as well as furnishings and durable household equipment.

The price of gasoline and other energy goods dropped 3.4%.

Clothing and footwear were also cheaper last month.

The cost of services increased 0.2%, lifted by higher prices

for housing and utilities as well as healthcare. Financial

services and insurance costs declined 0.3% after rising for five

straight months. These costs, together with housing, have been

among the major drivers of services inflation.

In the 12 months through May, the PCE price index increased

2.6% after advancing 2.7% in April. Last month's inflation

readings were in line with economists' expectations.

Inflation is receding after spiking in the first quarter as

525 basis points worth of rate hikes from the Fed since 2022

cool domestic demand. Inflation, however, continues to run above

the central bank's 2% target.

Financial markets saw a roughly 68% chance of a September

rate cut compared to about 64% before the data, though

policymakers recently adopted a more hawkish outlook. The Fed

has maintained its benchmark overnight interest rate in the

current 5.25%-5.50% range since last July.

U.S. stocks opened higher. The dollar was largely unchanged

against a basket of currencies. U.S. Treasury prices were mostly

higher.

SPENDING RISES MODERATELY

Excluding the volatile food and energy components, the PCE

price index edged up 0.1% last month, the smallest gain since

November. That followed an upwardly revised 0.3% rise in April.

The so-called core PCE price index was previously reported

to have gained 0.2% in April. Core inflation increased 2.6% on a

year-on-year basis in May, the smallest advance since March

2021, after rising 2.8% in April.

The Fed tracks the PCE price measures for monetary policy.

Monthly inflation readings of 0.2% over time are necessary to

bring inflation back to target.

PCE services inflation excluding energy and housing also

ticked up 0.1% last month after advancing 0.3% in April. This

so-called super inflation reading is being watched by

policymakers to measure progress in lowering price pressures.

Consumer spending, which accounts for more than two-thirds

of U.S. economic activity, increased 0.2% last month after

rising 0.1% in April, the report also showed.

Inflation fatigue, higher borrowing costs as well as

dwindling savings are holding back spending. Nonetheless,

consumer spending remains supported by a resilient labor market,

which continues to generate strong wage gains. Personal income

increased 0.5% after climbing 0.3% in April. Wages shot up 0.7%.

Income at the disposal of households after accounting for

inflation and taxes rose a solid 0.5%. Consumers saved more,

lifting the saving rate to 3.9% from 3.7% in April.

Spending adjusted for inflation rebounded 0.3% after

slipping 0.1% in April. The rise in the so-called real consumer

spending bodes well for growth in consumption this quarter.

Consumer spending slowed sharply in the first quarter,

helping to restrict the economy to a 1.4% annualized growth

pace. The economy grew at a 3.4% pace in the fourth quarter.

Growth estimates for the second quarter are mostly below a

2% rate.