U.S. consumer prices rose moderately in May, leading to the smallest annual increase in inflation in more than two years, though underlying price pressures remained strong, supporting views that the Federal Reserve (Fed) would keep interest rates unchanged on Wednesday while adopting a hawkish posture.

May CPI and Annual Increase

The Consumer Price Index (CPI) increased 0.1% last month as gasoline prices fell, the Labor Department said Tuesday. The CPI gained 0.4% in April. In the 12 months through April, the CPI climbed 4.0%. That was the smallest year-on-year increase since March 2021 and followed a 4.9% rise in April.

The annual CPI peaked at 9.1% in June 2022, which was the biggest increase since November 1981, and is subsiding as last year’s large rises drop out of the calculation.

Economists’ Forecast and Fed Policy Meeting

Economists polled by Reuters had forecast the CPI gaining 0.2% last month and increasing 4.1% year-over-year.

The report was published as Fed officials prepared to gather for a two-day policy meeting. Data this month offered a mixed picture of the labor market, with nonfarm payrolls increasing solidly in May, but the unemployment rate rising to a seven-month high of 3.7% from a 53-year low of 3.4% in April.

Fed’s Monetary Policy and Future Rate Increases

Economists believe that the gradual inflation and labor market slowdown gives the U.S. central bank enough room to skip raising interest rates on Wednesday for the first time since March 2022 when the Fed embarked on its fastest monetary policy tightening campaign in more than 40 years.

The Fed, which has hiked its policy rate by 500 basis points, is expected to leave the door open to further rate increases.

With the economy showing signs of slowing, economists argue that the Fed should pause further rate increases while assessing the impact of the steps its has taken so far to cool demand.

Core Inflation, Rents, and Used Cars and Trucks

Overall inflation is decelerating, thanks to energy and food costs. Food commodity prices have dropped back to levels seen prior to Russia’s invasion of Ukraine.

Inflation is, however, proving to be sticky excluding these volatile categories, and remains well above the Fed’s 2% target.

The so-called core CPI increased 0.4% in May, rising by the same margin for the third straight month.

High rents continued to put upward pressure on the core CPI, with used cars and trucks also providing a boost. The rise in used cars and trucks reflects the delayed impact of increases during winter and early spring.

Beyond May, however, core inflation is expected to slow, driven by a moderation in rents and a resumption in price declines for used cars and trucks. The rental vacancy rate rose to a two-year high in the first quarter, while independent measures have been showing rents on a downward trend.

Rent measures in the CPI tend to lag the independent gauges by several months. In the 12 months through May, the core CPI climbed 5.3% after increasing 5.5% in April.