By Lucia Mutikani
WASHINGTON, June 25 (Reuters) – U.S. inflation increased further in May, breaking above 4.0% for the first time in three years as the Middle East conflict boosted energy prices, and keeping an interest rate increase from the Federal Reserve this year on the table.
But with oil prices falling to pre-war levels on Thursday after the United States and Iran signed a preliminary peace deal, inflation likely peaked last month or is close to doing so. An easing in gasoline prices is anticipated. The impact on inflation could, however, be offset by rising prices for technology goods like semiconductors and electronics amid an artificial intelligence investment boom.
Fertilizer shortages because of the conflict were expected to raise food prices, economists said. Service prices, which increased strongly last month, were unlikely to abate quickly. Economists believed underlying inflation would remain elevated for a while. Financial markets are expecting a rate hike from the U.S. central bank in September.
“PCE price inflation remains too high and will keep the Fed on hold and mulling a potential rate hike at upcoming meetings,” said Scott Anderson, chief U.S. economist at BMO Capital Markets. “Services inflation … will not be easily tamed by falling energy prices. The fight between the hawks and the doves is sure to remain intense.”
The personal consumption expenditures price index surged 4.1% in the 12 months through May, the largest increase and first reading above 4.0% since April 2023, the Commerce Department’s Bureau of Economic Analysis said on Thursday.
PCE inflation rose by an unrevised 3.8% in April. The PCE price index climbed 0.4% over the month after rising by the same margin in April. The increase in PCE inflation was in line with economists’ expectations.
Goods prices increased 0.4% after rising 0.7% in April. Prices of gasoline and other energy goods shot up 6.5%, while food edged up 0.1%. The price of services jumped 0.5% after rising 0.3% in April. They were lifted by a 0.8% advance in the cost of transportation services as higher jet fuel prices boosted airfares. The cost of financial services and insurance increased 1.2%, reflecting a stock market rally. There were also strong rises in the costs of healthcare and other services.
Tehran took control of the Strait of Hormuz when the U.S. and Israel attacked Iran on February 28. On Thursday, Washington said shipments through the strait were approaching levels seen before the conflict.
Prior to the war, consumers were struggling with higher prices stemming from Trump’s sweeping import tariffs. The higher cost of living is a political liability for Trump and his Republican Party, seeking to retain control of Congress in the midterm elections in November, amid mounting frustration over his stewardship of the economy. Trump won the 2024 presidential election in part because of his promise to lower inflation.
Excluding the volatile food and energy components, the PCE price index increased 3.4% year-on-year in May. That was the biggest gain since October 2023 and followed a 3.3% rise in April. The so-called core PCE inflation advanced 0.3% over the month for the third month in a row.
The Fed tracks the PCE inflation measures for its 2% target. The Fed last week kept its benchmark overnight interest rate in the 3.50%-3.75% range, but updated quarterly projections showed policymakers expected to raise borrowing costs this year. Both PCE inflation measures were last below 2% in early 2021.
“While lower energy prices will provide some relief to headline inflation in the second half, other supply-side pressures are likely to persist,” said Gregory Daco, chief economist at EY-Parthenon. “As a result, headline inflation should moderate, but core inflation is likely to remain uncomfortably firm above the Fed’s 2% target.”
Financial markets saw a roughly 80% chance that the Fed will raise rates at the September 15-16 meeting, according to CME Group’s FedWatch tool. Stocks on Wall Street were trading higher. The dollar eased against a basket of currencies. U.S. Treasury yields fell.
CONSUMERS UNDETERRED BY HIGH INFLATION
Despite the high inflation last month, consumers boosted their spending, thanks to larger tax refunds this year and higher share prices, which have cushioned some of the pain at the pump. Households are also tapping into savings and saving less. Consumer spending, which accounts for more than two-thirds of economic activity, jumped 0.7% in May after rising 0.4% in April. Some of the rise reflected higher prices.
Inflation-adjusted spending rose 0.3%, keeping consumption on track to speed up this quarter after nearly stalling in the January-March quarter. Income at the disposal of households rebounded 0.3% after declining for three straight months. But it was unchanged year-on-year in May.
Income was supported by wage gains amid a stable labor market and one-off government transfers to farmers, impacted by, among others, trade wars and inflation. The saving rate was steady near a four-year low of 3.0%.
Consumers are joining forces with businesses to support the economy, though some of the drivers, including tariff refunds and the FIFA World Cup tournament, jointly hosted by the U.S., Canada and Mexico, are temporary. A separate report from the Commerce Department’s Census Bureau showed businesses boosting spending on a range of goods in May.
Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, increased 1.6% last month after declining 0.7% in April. Some of the rise in these so-called core capital goods, however, reflected higher prices, especially for memory chips.
Business spending on equipment recorded double-digit growth in the first quarter. Gross domestic product growth estimates for the second quarter are converging around a 2.5% annualized rate. The economy grew at a 2.1% pace in the January-March quarter.
“The economy in the second and third quarters is being propelled forward by a number of special factors, tariff refunds, personal tax refunds and the World Cup events,” said Brian Bethune, an economics professor at Boston College. “All of those factors roll off at the end of the third quarter.”
(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)
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