US consumer inflation breaks above 4% as Iran war raises energy prices

By Lucia Mutikani

WASHINGTON, June 10 (Reuters) - U.S. consumer inflation increased at its fastest pace in three years in May, boosted by surging prices for energy products amid the Middle East conflict, and giving more ammunition for the Federal Reserve to keep interest rates unchanged into 2027.

The third straight month of strong increases in the Consumer Price Index reported by the Labor Department on Wednesday underscored the mounting pressure on households, who are increasingly tapping their savings to fund spending.

Inflation eroded wages for a second consecutive month in May, which could weigh on overall economic growth. The soaring cost of living is a political liability for President Donald Trump and his Republican Party, seeking to retain control of Congress in the midterm elections in November. Trump won the 2024 presidential election in large part because of his promise to lower inflation, but has seen his approval rating tumble as frustration mounts over his handling of the economy.

"Americans are getting squeezed financially by inflation," said Heather Long, chief economist at Navy Federal Credit Union. "It's not just bad vibes about the economy now, there are real financial pressures, especially on middle-class and lower-income households."

The Consumer Price Index increased 4.2% in the 12 months through May, the largest gain since April 2023, the Labor Department's Bureau of Labor Statistics said. The CPI advanced 3.8% year-on-year in April and rose 3.3% in March. Prices increased 0.5% over the month after climbing 0.6% in April. The rise in inflation was in line with economists' expectations.

The U.S. central bank tracks the Personal Consumption Expenditures Price Indexes for its 2% inflation target. All inflation measures are running well above the Fed's target.

Real average hourly earnings dropped 0.7% in the 12 months through May after falling 0.3% in April.

A 3.9% jump in the price of energy goods accounted for more than 60% of the rise in the monthly CPI. Energy prices rose 3.8% in April. They vaulted 23.5% in the 12 months through May. Gasoline prices accelerated 7.0% over the month and were up 40.5% from a year ago. Prices at the pump have retreated in recent weeks as oil prices eased, raising cautious optimism among economists that May could be the peak in CPI inflation.

But the U.S. and Iran engaged in tit-for-tat strikes on Tuesday, with President Donald Trump saying on Wednesday Tehran had taken too long to negotiate a deal and would ?now "have to pay the price." Iran has said it would reassess diplomatic engagement with Washington.

Inflation last month was also lifted by higher rents. While food price growth slowed after accelerating in April, risks remained to the upside as the war, now in its fourth month, has raised the cost of fertilizers. Grocery prices edged up 0.1%, with increases in the prices of nonalcoholic beverages, cereals and bakery products as well as fruits and vegetables partially offset by decreases in the cost of meat and dairy products.

Stocks on Wall Street were lower. The dollar was steady against a basket of currencies. U.S. Treasury yields rose.

BAR REMAINS HIGH FOR RATE HIKE

Following news last week that the economy posted a third successive month of above-expectations job growth in May and the unemployment rate staying at 4.3% for three months in a row, financial markets started pricing in a rate hike.

The CPI report, however, suggested the oil price shock was not yet spilling over to the broader economy, and remained mostly confined to the transportation sector. There were also signs that the pass-through from import tariffs was fading.

Economists continued to believe the bar remained high for the central bank to tighten monetary policy. They expected the Fed to leave its benchmark overnight interest rate in the 3.50%-3.75% range at next week's meeting, but ditch its easing bias. Excluding the volatile food and energy components, the CPI increased 2.9% year-on-year in May after rising 2.8% in April.

The so-called core CPI gained 0.2% over the month after rising 0.4% in April. The slowdown in the monthly core CPI mostly reflected a 1.7% drop in motor vehicle insurance, the largest decline since October 2020.

Economists said the decrease was at odds with the reality of higher motor vehicle insurance. They said the drop was unlikely to be reflected in the core PCE inflation measure, which uses the component from the Producer Price Index report.

Also, while the artificial intelligence spending boom is driving up prices of computers and software, those have a smaller weighting in the core CPI basket. The weighting is larger in the core PCE inflation basket.

Prices for household furnishings and supplies fell while those of apparel rose moderately, suggesting the inflation boost from import duties was drawing to a close. New vehicle prices fell and the cost of used cars and trucks edged up 0.1%. Core goods prices dipped 0.1%.

Rents increased a solid 0.4%, with owners' equivalent rent of primary residence rising 0.3%. Rent measures had increased 0.5% in April, boosted by a one-time adjustment after last year's shutdown of the government prevented data collection. Economists had expected the effects to fade in May.

Airline fares advanced 2.7% after increasing 2.8% in April, reflecting higher jet fuel prices. They soared 26.7% year-on-year. The cost of healthcare increased 0.5%, driven by dental and hospital services. The overall cost of services, excluding energy, climbed 0.3% after accelerating 0.5% in April.

Based on the CPI data, economists estimated that PCE inflation increased 0.4% in May, which would match April's gain and translate into an annual increase of 4.0%. PCE inflation advanced 3.8% in the 12 months through April. Estimates for May core PCE inflation ranged between 0.3% and 0.4% over the month. Underlying inflation was forecast increasing 3.3% year-on-year.

"If we don't see a moderation in energy prices soon, it will only be a matter of time before we see more visible spillovers into other goods and services categories and into inflation expectations," said Scott Anderson, chief U.S. economist at BMO Capital Markets. "The Fed's priority right now remains inflation. The potential for future rate hikes is still very much on the table."

?

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)