Inflation is rapidly cooling from its hottest pace in 40 years, providing some relief to Americans whose wallets have been strained by price increases in everything from groceries to housing. 

The Consumer Price Index grew at an annual rate of 3% in June — the smallest increase since March 2021, the Labor Department said on Wednesday. 

While that's good news for consumers as they grapple with their daily expenses, the latest inflation figures are more than a reflection of the price pressures facing U.S. households. The data also influences key financial decisions by policymakers that may impact millions of consumers' budgets later this year, ranging from home buyers to senior citizens.

The Federal Reserve looks at the CPI data when deciding whether to increase interest rates; it also considers a different inflation metric known as the Personal Consumption Expenditures Price Index, which tends to run lower than CPI. Although both indexes show inflation is cooling, it still remains higher than the Fed's target rate of 2% — especially so-called "core" inflation, which strips out volatile fuel and food prices. Core inflation rose 4.8% last month, more than double the Fed's target.

June's inflation "is really only a small step in the right direction," noted Brian Coulton, chief economist at Fitch Ratings, in an email. "Core inflation remains just under 5% on both a year-on-year and three-month annualized basis, which is far too high."

Here's what the latest data means for your money. 

How does inflation work?

Inflation is the increase in prices of goods and services, with the Consumer Price Index measuring a basket of items that are typically purchased by U.S. households, ranging from groceries to cars. 

In the past two years, inflation suddenly jumped higher, reaching a 40-year high in 2022. But the reasons for the inflationary spike are debated among economists, with some blaming corporate price gouging and others pointing to more classic supply-and-demand issues. 

Many economists have pointed to strong pandemic demand sparked by stimulus checks, coming at a time when supply was constrained by supply-chain breakdowns, as the cause for the run-up in inflation.

What does the June CPI mean for interest rates?

Sure, inflation is coming down, but it may not be falling fast enough to satisfy the Federal Reserve. 

Some economists are forecasting that the central bank will boost interest rates by one-quarter of a percentage point at its meeting later this month, scheduled for July 25-26. If the Fed raises rates again in July, consumers could face even higher borrowing costs.

Credit card APRs — already at a historic high — and mortgage rates could continue to rise if the Fed boosts rates in July because such debt tends to move in tandem with the underlying Federal Funds Rate. 

Even so, June's cooling inflation suggests that the Fed could ease up on interest rate hikes after July, some economists said.

"It is enough on a standalone basis for the market to put in question the Fed's dot projections of two additional hikes left this year," noted Alexandra Wilson-Elizondo, deputy CIO of multi asset solutions at Goldman Sachs Asset Management, in an email.

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Does this impact Social Security benefits? 

Yes, because Social Security benefits are adjusted annually for inflation — and the Social Security Administration bases its cost-of-living adjustment (COLA) on inflation data from July, August and September. 

While CPI data for those three months isn't available yet, some forecasters are projecting their estimates for the 2024 COLA based on inflation trends so far this year. With prices cooling, some are projecting that the nation's seniors will see a much smaller boost next year.

The COLA could be 3% next year, based on the June data, according to the Senior Citizens League, an advocacy group for older Americans. Another group, the think-tank Committee for a Responsible Federal Budget, said on Wednesday it estimates Social Security beneficiaries will receive a COLA of 2.6% to 3.3%, depending on where inflation falls in the next three months.

Are any items still seeing big price increases?

A few products and services are still seeing relatively high price increases, according to the June data. Housing, which includes rent and what homeowners pay for their properties, jumped 7.8% last month. Car insurance surged almost 17%, while restaurant prices jumped 7.7%, the Labor Department said on Wednesday. 

Housing inflation remains a major concern for consumers, and was the largest contributor to June's rise in prices. 

But economists expect that housing prices will begin to dip later in the year, helped by new construction. "Rents have been coming down in places where new rental construction has been coming online," noted Bright MLS chief economist Lisa Sturtevant. "More supply, even with steady or rising demand, lowers costs."

Where are Americans getting price breaks?

Prices are falling in several major spending categories, with energy costs representing the biggest drop. Gasoline is about 27% cheaper than a year earlier, labor data shows. Used car prices are also lower, with a 5.2% dip last month, while airline fares plunged almost 19%. 

On the grocery front, some items are paring their pandemic price gains, with eggs dropping almost 8%. That follows a surge in egg prices earlier this year that stunned some consumers and prompted some people to raise their own backyard chickens. Other grocery items with price cuts include pork, bacon and butter. 

The slowdown in inflation "will buy investors time and give them the opportunity to catch their breath," noted Wilson-Elizondo of Goldman Sachs.

In:
• Inflation
• Social Security