U.S. consumer prices rose modestly in June and registered their smallest annual increase in more than two years as inflation subsided further, but probably not fast enough to discourage the Federal Reserve from resuming raising interest rates this month.

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The report from the Labor Department on Wednesday also showed underlying consumer prices posting their smallest monthly gain since August 2021. The considerable slowdown in underlying inflation ignited a rally on the stock market, with investors convinced that the U.S. central bank's fastest monetary policy tightening cycle since the 1980s was drawing to a close.

"Inflation isn't dead, but the extraordinary pandemic push on prices from shortages and shift to stay-at-home purchases is clearly over, and the Fed for the first time has the upper hand in its inflation fight," said Christopher Rupkey, chief economist at FWDBONDS in New York.

The CPI gained 0.2% last month after edging up 0.1% in May. Shelter, which includes rents, accounted for 70% of the rise in the CPI last month. There was also an increase in motor vehicle insurance as well as gasoline prices, which rose 1.0%. These gains offset a decrease in the price of used cars and trucks.

Food prices ticked up just 0.1%. The cost of food consumed at home was unchanged. Fruits and vegetables prices increased 0.8%, but the cost of meat and fish was cheaper and eggs fell 7.3%.

In the 12 months through June, the CPI advanced 3.0%. That was the smallest year-on-year increase since March 2021 and followed a 4.0% rise in May.

Economists polled by Reuters had forecast the CPI rising 0.3% last month and climbing 3.1% year-on-year.

Annual consumer price rises have retreated sharply from their 9.1% peak in June 2022, which was the biggest increase since November 1981, as last year's large rises drop out of the calculation. Nevertheless, inflation remains well above the Fed's 2% target, with the labor market still tight.

Though employment gains were the smallest in 2-1/2 years in June, the unemployment rate fell close to historically low levels and wage growth was strong.

U.S. stocks opened sharply higher. The dollar fell against a basket of currencies. U.S. Treasury prices rose.

CORE INFLATION SLOWING

Financial markets have almost priced in a 25 basis points interest rate increase at the Fed's July 25-26 policy meeting, according to CME's FedWatch tool.

The U.S. central bank skipped raising rates in June. The Fed has hiked its policy rate by 500 basis points since March 2022.

The improving inflation environment was underscored by a moderation in the pace of increase in underlying prices.

Excluding the volatile food and energy categories, the CPI increased 0.2% in June, the smallest gain since August 2021. It was the first time in six months that the so-called core CPI did not post monthly gains of at least 0.4%.

The core CPI was lifted by a 0.4% increase in shelter costs, which followed a 0.6% rise in May. Owners' equivalent rent, a measure of the amount homeowners would pay to rent or would earn from renting their property, climbed 0.4% after rising 0.5% for three straight months.

The cost of motor vehicle insurance jumped 1.7%, while prices for apparel rose 0.3%. But prices for used cars and trucks dropped 0.5% and the cost of new cars was unchanged.

Airline tickets were 8.1% cheaper. There were also decreases in the prices of communication services and household furnishings and operations. Healthcare costs were unchanged as were the prices of prescription medication.

In the 12 months through June, the core CPI rose 4.8%. That was the smallest year-on-year gain since October 2021 and followed a 5.3% increase in May.

Core inflation is expected to continue receding in the months ahead, with the labor market cooling and independent measures showing rents on a downward trend. Rent measures in the CPI tend to lag the independent gauges by several months.

The Institute for Supply Management's measure of prices paid by services businesses for inputs dropped in June to the lowest level since March 2020. Economists view the ISM services prices paid measure as a good predictor of personal consumption expenditures (PCE) inflation.

They see a correlation between this price measure and the core PCE services excluding housing. This so-called super core is being closely watched by Fed officials to gauge progress in the fight against inflation.