Inflation eased slightly last month but held near its highest level in four decades even as gas prices fell and supply chains improved.

The Bureau of Labor Statistics' latest Consumer Price Index (CPI) reflected a year-over-year increase of 8.5% in July, down from the prior month's 40-year high of 9.1%. Consensus economists were expecting last month's reading to show an 8.7% increase, according to estimates compiled by Bloomberg.

On a monthly basis, the broadest measure of inflation was unchanged after rising 1.3% in June.

Core CPI, which excludes the volatile food and energy components of the report, remained firm, climbing at an annual 5.9%, in line with June's figure.

A downward trend in gasoline prices over more than 50 consecutive days provided some relief to U.S. consumers last month after record energy costs pushed inflation to the highest reading of the cycle in June.

The gasoline index fell 7.7% in July, marking the largest month-over-month drop in this component of the report since April 2020, while energy prices fell 4.6% over the month.

Still, inflationary pressures remained strong across other components of the report and declining gas and energy prices were offset by increases in the food and shelter indexes, the BLS report indicated.

“The drop in gasoline prices has been very welcome, but that doesn’t solve the inflation problem," Bankrate Chief Financial Analyst Greg McBride said in emailed comments, pointing to a core reading that remained up nearly 6% over the past year. "Consumers are getting a break at the gas pump, but not at the grocery store."

July's data showed a continued rise in the food index, up 1.1% over the month as the food-at-home index rose 1.3%.

"The easing of overall inflation coupled with strong labor market conditions could provide some optimism to the Federal Reserve that the rate hikes are working and that the elusive 'soft landing'—that is, bring inflation down without sending the labor market tumbling—is a possibility," Bright MLS Chief Economist Lisa Sturtevant said in a note. "However, high housing costs and the challenges they post to prospective buyers and renters will continue to be a strain on the economy."

The cost of shelter, which comprises nearly a third of the index, continued to charge higher, up 5.7% over the year.

Markets reacted positively to the report, with all three major indexes surging following the release as investors hoped a moderation in consumer prices would prompt Fed policymakers to scale back the magnitude of interest rate increases this fall.

Although the pace of inflation cooled last month, prices still rose at a record clip and are likely to be pressured by renewed traction in wage gains among workers.