The second straight month of benign consumer price readings reported by the Labor Department on Thursday should help to bolster confidence among officials at the U.S. central bank that inflation is cooling after surging in the first half of the year.

The report also showed a measure of underlying inflation posting the smallest increase since August 2021 on a monthly basis. Financial markets saw a very high probability of the Fed starting its easing cycle in September.

"Barring rogue price data in July, the Fed has a checkered flag to reduce rates in September," said Brian Bethune, an economics professor at Boston College. "This guidance will be solidified at the July meeting."

The consumer price index dipped 0.1% last month, the first drop since May 2020, after being unchanged in May, the Labor Department's Bureau of Labor Statistics said. The CPI was weighed down by a 3.8% drop in gasoline prices, which followed a 3.6% decrease in May. Shelter costs, which include rents, increased a moderate 0.2% after advancing 0.4% in May.

Food prices rose 0.2% after edging up 0.1% in May. In the 12 months through June, the CPI climbed 3.0%, the smallest gain since June 2023. That followed a 3.3% advance in May.

Economists polled by Reuters had forecast the CPI ticking up 0.1% and gaining 3.1% year-on-year.

The annual increase in consumer prices has slowed from a peak of 9.1% in June 2022. June's moderation narrowed the CPI gap with the measures tracked by the Fed for its 2% inflation target. The Personal Consumption Expenditures (PCE) price indexes both increased 2.6% in May.

The CPI report followed news last week that the unemployment rate rose to a 2-1/2-year high of 4.1% in June from 4.0% in May.

Economic growth has also slowed in response to the central bank's hefty rate hikes in 2022 and 2023, with second-quarter gross domestic product forecast near the 1.8% annualized rate that policymakers view as the non-inflationary growth pace.

Fed Chair Jerome Powell has acknowledged the recent improving trend in price pressures, but told lawmakers this week he was not yet ready to declare inflation had been beaten and that "more good data" would strengthen the case for rate cuts.

Financial markets saw a roughly 85% chance of a rate cut at the Fed's September meeting, compared with about a 70% chance seen before the report. U.S. Treasury yields fell. The dollar slipped against a basket of currencies.

BROAD PRICE MODERATION

The central bank has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range since last July. It has hiked its policy rate by 525 basis points since 2022.

Excluding the volatile food and energy components, the CPI gained 0.1% in June. That was the smallest increase in the so-called core CPI since August 2021 and followed a 0.2% rise in May. The core CPI was restrained by a moderation in rents, which increased 0.3%, the smallest gain since August 2021.

Consumers also got relief from healthcare costs, which rose 0.2% after advancing 0.5% in May. Airline fares were cheaper as were used cars and trucks, new motor vehicles and communication services. But motor vehicle insurance prices rebounded 0.9% after falling 0.1% in May.

Household furnishings and operations cost more as did personal care, education, recreation and apparel.

In the 12 months through June, the core CPI increased 3.3%. That was the smallest year-on-year increase since April 2021 and followed a 3.4% rise in May.

A separate report from the Labor Department on Thursday showed first-time applications for unemployment benefits dropped more than expected last week, but volatility around this time of the year as automobile manufacturers idle plants for retooling makes it harder to get a clean read on the labor market.

Initial claims for state unemployment benefits fell 17,000 to a seasonally adjusted 222,000 for the week ended July 6, the lowest level since late May. Economists had forecast 236,000 claims in the latest week.

The claims data included the Independence Day holiday. Claims tend to be volatile around holidays, and auto makers typically shut down assembly plants starting the July 4 week to retool for new models.

The timing can, however, vary from one manufacturer to the next, which can throw off the model that the government uses to smooth out the data for seasonal fluctuations.

While this is likely injecting noise into the claims data, signs are mounting that the labor market is losing steam as hefty interest rate increases from the Federal Reserve in 2022 and 2023 cool economic activity.

There were 1.22 job openings for every unemployed person in May, not much higher than the 1.19 average in 2019. The unemployment rate rose to a 2-1/2-year high of 4.1% in June from 4.0% in May. Claims had since June been stuck in the upper end of their 194,000-243,000 range for this year.

The number of people receiving benefits after an initial week of aid, a proxy for hiring, slipped 4,000 to a seasonally adjusted 1.852 million during the week ending June 29, the claims report showed.