An inflation measure closely tracked by the Federal Reserve slowed to its smallest annual increase in three years, prompting some Wall Street economists to forecast an increased likelihood that the central bank could cut rates in September.

The personal consumption expenditures index, or PCE, rose 2.6% in May on a year-over-year basis, the U.S. Commerce Department said on Friday. That represents its lowest increase since March 2021, according to EY senior economist Lydia Boussour in a Friday report, adding that it signals "cooler consumer spending momentum and easing inflation."

The Federal Reserve earlier this month scaled back its forecast to just one rate cut in 2024 from its prior expectation for three reductions due to stubborn inflation, which remains higher than the central bank's 2% annual target. Friday's PCE numbers could portend an increasing likelihood that the Fed could cut rates at its September meeting, Wall Street economists said.

"[T]he market is now giving the Fed the green light to consider a rate cut at their September 18th meeting. Currently, the odds for a rate cut at that meeting are approximately 75%," wrote John Kerschner, head of U.S. securitised products at Janus Henderson Investors, in a Friday email.

Excluding volatile food and energy prices, so-called core inflation rose 0.1% from April to May, the smallest increase since the spring of 2020, when the pandemic erupted and shut down the economy.

Prices for physical goods actually fell 0.4% from April to May. Gasoline prices, for example, dropped 3.4%, furniture prices 1% and the prices of recreational goods and vehicles 1.6%. On the other hand, prices for services, which include items like restaurant meals and airline fares, ticked up 0.2%.

The Fed has raised its benchmark rate 11 times since 2022 in its drive to curb the hottest inflation in four decades. Inflation has cooled substantially from its peak in 2022, yet average prices remain far above where they were before the pandemic, a source of frustration for many Americans and a potential threat to President Joe Biden's re-election bid.

-- With reporting from the Associated Press.

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