An influential economic gauge for the Federal Reserve, the core Personal Consumption Expenditures (PCE) price index, disclosed on Friday that inflation in May slowed to its lowest annual rate in more than three years.

According to a report from the Commerce Department, the core PCE price index, which excludes volatile food and energy prices, edged up just 0.1% on a seasonally adjusted basis for the month. Compared to a year earlier, it rose by 2.6%, marking a 0.2 percentage point decline from April levels. These figures closely matched expectations outlined by Dow Jones.

Inclusive of food and energy costs, headline inflation remained flat month-over-month and also recorded a 2.6% increase year-over-year, aligning with market forecasts.

San Francisco Fed President Mary Daly expressed optimism regarding the inflation data in an interview on CNBC's "Squawk Box," noting, "It is additional evidence that monetary policy is effective; inflation is gradually cooling. This news is a relief for businesses and households grappling with persistently high inflation. It underscores the effectiveness of our policy."

The Federal Reserve emphasizes the PCE inflation measure over the Consumer Price Index (CPI) from the Bureau of Labor Statistics, viewing PCE as providing a broader perspective on inflation, accounting for shifts in consumer behavior such as substituting purchases when prices fluctuate.

Despite the positive trend in inflation moderation, the Bureau of Economic Analysis report highlighted that while personal income rose by 0.5% month-over-month, slightly surpassing the 0.4% estimate, consumer spending only increased by 0.2%, falling short of the anticipated 0.3%.

The moderation in prices during May was driven by a 0.4% decrease in goods prices and a significant 2.1% drop in energy prices, which offset minor increases of 0.2% in services and 0.1% in food prices.

However, the report underscored that housing prices continued their ascent, rising 0.4% for the fourth consecutive month. This sustained increase in shelter-related costs has proven more resilient than expected by Federal Reserve officials, influencing their deliberations on interest rates for the year.

Following the report's release, stock market futures exhibited modest gains, while Treasury yields trended lower during the session.

Investors closely monitor Federal Reserve communications on future interest rate adjustments. Initial expectations for six rate cuts in 2024 have been revised downward to anticipate just two, starting in September. During their June meeting, Fed officials indicated a single reduction this year.

Seema Shah, chief global strategist at Principal Asset Management, commented on the PCE figures, stating, "The absence of surprises in today's PCE number provides relief and will be welcomed by the Fed. However, the path forward remains uncertain. Further inflation deceleration, ideally alongside additional evidence of labor market softening, will be pivotal for a potential initial rate cut in September."

The Federal Reserve targets a 2% inflation rate and initiated interest rate hikes in March 2022, initially attributing inflation to temporary effects of the Covid-19 pandemic. The last rate increase occurred in July 2023, setting the benchmark overnight borrowing range at 5.25%-5.50%, the highest in over two decades.

Recent economic indicators suggest a resilient economy despite the Federal Reserve's assertive monetary tightening. Gross Domestic Product (GDP) expanded at a 1.4% annualized rate in the first quarter and is projected to accelerate to 2.7% in the second quarter, according to the Atlanta Fed.

While signs of labor market softening are emerging, with ongoing jobless claims reaching levels not seen since November 2021, the unemployment rate remains historically low at 4%, albeit with a gradual uptick.

The coming months will be pivotal for the Federal Reserve as it navigates evolving economic conditions and aims to fulfill its dual mandate of price stability and maximum sustainable employment.