US consumer prices posted their largest monthly decline in more than six years in June, as a sharp drop in energy costs provided temporary relief from the inflationary pressures seen earlier this year, according to data released Tuesday by the US Bureau of Labor Statistics.

The Consumer Price Index (CPI), a broad measure of goods and services prices across the US economy, came in below market expectations across the board. On a seasonally adjusted basis, the index fell 0.4% from the previous month, bringing the annual inflation rate down to 3.5%.

Economists surveyed by Dow Jones had expected a monthly decline of 0.2% and an annual inflation rate of 3.8%, following May's reading of 4.2%. The monthly decline in headline inflation was the largest since April 2020.

Energy and services drive inflation slowdown

Core inflation, which excludes food and energy prices, was unchanged on a monthly basis, bringing the annual rate to 2.6%.

Markets had expected core CPI to rise 0.2% in June, with the annual rate easing to 2.9% from 2.9% in May.

The energy index fell 5.7% during June, marking its largest monthly decline since April 2020. Despite the monthly drop, energy prices remained 15.7% higher than a year earlier, driven by a 26.7% annual increase in gasoline prices.

Meanwhile, both gasoline and fuel oil prices declined by more than 9% during the month.

Services inflation, a key measure closely monitored by Federal Reserve officials as an indicator of longer-term price trends, also eased noticeably. Services prices excluding energy were unchanged, shelter costs rose just 0.1%, and transportation services fell 0.3%.

Food prices increased 0.2%, new vehicle prices were unchanged, while used cars and trucks fell 0.2%. Apparel prices declined 0.6%, a category that is particularly sensitive to energy costs and tariffs.

Markets scale back tightening expectations despite continued rate hike outlook

Following the release of the data, US stock futures moved higher, while Treasury yields fell sharply.

Although markets continue to expect the Federal Reserve to raise interest rates at its September meeting, the probability of a rate hike declined to 63%, down from more than 75% a day earlier, according to CME Group's FedWatch tool.

The Federal Reserve's benchmark overnight interest rate currently remains in a target range of 3.50%-3.75%.

Heather Long, Chief Economist at Navy Federal Credit Union, said June finally brought some welcome relief on inflation, giving the Federal Reserve more room to wait and assess incoming data. However, she warned that the improvement could prove temporary if the conflict with Iran intensifies again, adding that it remains too early to conclude that the inflation story has fully turned.

While the report provided encouraging news for financial markets, it is unlikely to be sufficient to convince Federal Reserve officials to begin cutting interest rates anytime soon, with markets still broadly expecting a rate hike in September.

Federal Reserve Governor Christopher Waller said on Monday that several more months of favorable inflation readings would be needed before he would be convinced inflation is firmly moving back toward the central bank's 2% target.

The report followed a series of hawkish remarks from Federal Reserve officials on inflation. Following their June meeting, policymakers reaffirmed in their statement that the Federal Open Market Committee remains committed to achieving price stability.

New Federal Reserve Chair Kevin Warsh has also made fighting inflation a central theme since taking office in May, despite previously expressing confidence that interest rates could eventually be lowered.

In prepared remarks for his congressional testimony on Tuesday, Warsh said, "The Federal Reserve's first objective is to achieve the right monetary policy, or get as close to it as possible. That is our clear and unwavering goal, and it remains our guiding principle. If we succeed in setting policy correctlyand we willthe inflation surge of the past five years will become a thing of the past."

However, the recent slowdown in inflation could prove temporary depending on developments in the Middle East.

A sharp decline in oil prices during June, following easing regional tensions, helped slow inflation. But US President Donald Trump declared last week that the ceasefire with Iran had ended after both sides resumed military attacks, sending oil prices sharply higher on Monday, with gains extending into Tuesday.

Ryan Weldon, Chief Investment Officer at IFM Investors, said the longer the conflict lasts, the greater the likelihood that the Federal Reserve will have to raise interest rates, fulfilling Kevin Warsh's pledge during his first meeting as Fed chair to restore price stability.