US producer inflation muted; labor market still tight

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. producer prices barely rose in June and the annual increase in producer inflation was the smallest in nearly three years, further evidence that the economy had entered a period of disinflation even as the labor market remains tight.

The report from the Labor Department on Thursday followed news on Wednesday that consumer prices rose slightly in June. The run of softer inflation readings likely will push the Federal Reserve closer to ending its fastest monetary policy tightening campaign since the 1980s.

The U.S. central bank is expected to raise interest rates later this month after holding them steady in June.

"The Fed's expected hike at the end of the month will probably be the last of the cycle," said Bill Adams, chief economist at Comerica Bank in Dallas. "Things could still go wrong if another shock exerts new upward pressure on prices, but with the economy slowing and a modest margin of slack opening in its productive capacity, that seems less of a risk now."

The producer price index for final demand nudged up 0.1% last month. Data for May was revised to show the PPI falling 0.4% instead of the previously reported 0.3%.

In the 12 months through June, the PPI climbed 0.1%. That was the smallest year-on-year gain since August 2020 and followed a 0.9% increase in May.

Economists polled by Reuters had forecast the PPI would rise 0.2% on the month and advance 0.4% on a year-on-year basis.

Inflation is easing as supply chain bottlenecks disappear and demand for goods slows in response to higher interest rates. Last year's surge in prices is also dropping out of the calculation of annual inflation rates.

The Fed has raised its policy rate by 500 basis points since March 2022. Financial markets have priced in a 25-basis-point rate increase at the central bank's July 25-26 policy meeting, according to CME's FedWatch tool.

A 0.2% increase in the prices of services accounted for the rise in the monthly PPI last month. Services had increased 0.2% in May. They were boosted by a 5.4% surge in deposit services, including checking and savings accounts.

There were also increases in the cost of food and alcohol retailing. Wholesale hotel and motel accommodation prices rose 2.3%, while the cost of hospital inpatient care increased 0.6% and airline tickets rebounded 1.1%. But portfolio management fees dropped 0.3%, declining for a second straight month.

These services components feed into the calculation of the Personal Consumption Expenditures (PCE) price indexes, the inflation measures tracked by the Fed for its 2% target.

The cost of transporting freight by road fell 2.1% and plunged 13.7% year-on-year, the most since 2010.

Goods prices were unchanged after dropping 1.6% in May. Energy prices rebounded 0.7% while the cost of food fell for a third consecutive month. Goods prices dropped 4.4% on a year-on-year basis, the largest decline since April 2020.

Factory goods deflation and declining freight costs suggested that the economy was slowing, potentially removing the need for the Fed to raise rates beyond this month.

"This is another positive report for investors desperate to see inflation dissipate," said Jeffrey Roach, chief economist at LPL Financial in Charlotte, North Carolina.

Stocks on Wall Street were trading higher. The dollar fell against a basket of currencies. U.S. Treasury prices rose.

CORE INFLATION SLOWING

Excluding the volatile food and energy components, the so-called core goods prices fell 0.2% last month after climbing 0.1% in May.

The narrower measure of core PPI, which strips out food, energy and trade services components, edged up 0.1% after being unchanged in May. In the 12 months through June, the core PPI advanced 2.6%. That was the smallest year-on-year gain since February 2021 and followed a 2.8% increase in May.

With the CPI and PPI data in hand, economists estimated that the core PCE price index rose 0.2% in June. That would be the smallest gain since last November and would follow a 0.3% increase in May. The core PCE price index was forecast advancing 4.2% year-on-year in June, which would be the smallest rise since September 2021, after increasing 4.6% in May.

While inflation is slowing, the labor market remains tight. A separate report from the Labor Department showed initial claims for state unemployment benefits dropped 12,000 to a seasonally adjusted 237,000 for the week ended July 8. Economists had forecast 250,000 claims for the latest week.

The data included the July 4 Independence Day holiday, which could have caused some distortions. Automakers also normally idle plants in July to retool for new models. But those temporary plant closures do not always happen around the same time, which could throw off the model that the government uses to strip out seasonal fluctuations.

Claims, relative to the size of the labor market, are well below the 280,000 level that economists say would signal a significant slowdown in job growth.

The Fed's "Beige Book" report on Wednesday described demand for labor as having "remained healthy" in June, with pockets of worker shortages in health care, transportation and hospitality as well as high-skilled positions.

But it also noted that "some contacts reported that hiring was getting more targeted and selective."

The number of people receiving benefits after an initial week of aid, a proxy for hiring, increased 11,000 to a still-low 1.729 million during the week ending July 1, the claims report showed. The historically low so-called claims suggests some laid-off workers are quickly finding new employment.

But some economists warned the labor market could slow significantly by year end, arguing that factory goods deflation combined with the punitive borrowing costs pointed to a recession.

"Deflation in core producer prices means demand is weak so production cuts and the loss of new orders may eventually engender belt-tightening and layoffs later on in the second half of the year," said Christopher Rupkey, chief economist at FWDBONDS in New York.

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Paul Simao)