U.S. CPI Preview: May Inflation Expected at 4.2%, Highest in Three Years as Iran War Ripples Through Consumer Prices

Key Takeaways

• 4.2% annual CPI expected: If confirmed, it would mark the highest inflation reading since April 2023.
• Core CPI seen at 2.9%: Up from 2.8% in April, suggesting price pressures are broadening beyond energy.
• Iran war the primary driver: Fuel disruptions from the conflict are spreading costs to other products, echoing the post-pandemic supply chain shock.
• Wells Fargo’s warning: “The inflationary effects of the Iran conflict continue to ripple through consumer prices. Higher costs of necessities continue to pinch consumers.”
• Broadening pass-through the key risk: Deutsche Bank’s Jim Reid warns that evidence of wider price spread “would add to concerns about inflation persistence.”
• Fed meets next week: The central bank is widely expected to hold rates, but an in-line or hot reading would amplify rate hike pressure for later in the year.
• New Fed Chair Kevin Warsh presides: Wednesday’s CPI will be the first major data point for the incoming chair.
• Rate hike bets growing: Some Fed officials have become more vocal about potential hikes as the labor market holds firm.
• Fed’s dual mandate: The central bank must balance 2% core inflation with high employment, currently under strain on both fronts.

A report on the Consumer Price Index from the Bureau of Labor Statistics is due out on Wednesday. Economists expect it to show the cost-of-living measure rose 4.2% over the 12 months ending in May, which would be the largest annual increase since April 2023.

“Core” prices, which exclude the volatile costs of food and energy, are expected to have risen 2.9% over the year, up from 2.8% in April.

The Iran War’s Inflationary Ripple Effect

A report in line with expectations would show inflation following a trajectory similar to that in the immediate aftermath of the pandemic, and for a similar reason. Supply chain disruptions are pushing up prices for important commodities, especially fuel, and those price hikes are spreading to other products. This time, however, the largest disruption is not COVID-19 but the Iran war’s restriction of oil and other resources through the Strait of Hormuz.

“The inflationary effects of the Iran conflict continue to ripple through consumer prices,” economists at Wells Fargo led by Tom Porcelli wrote. “Higher costs of necessities continue to pinch consumers.”

What This Means for the Economy

Rising inflation is one of the biggest threats to the health of the overall economy, since it can hurt consumer spending and could force the Federal Reserve to slow growth by raising interest rates.

The report could also have significant implications for Fed policy. A jump in prices could put further pressure on the central bank to raise its key interest rate, pushing up borrowing costs across the economy to discourage spending and counter rising inflation.

That could be especially true if price hikes prove widespread and are not limited to gasoline, indicating that higher transportation costs are being passed on to consumers.

“Evidence of broader pass-through would add to concerns about inflation persistence,” Jim Reid, head of macro research and thematic strategy at Deutsche Bank, wrote in a commentary.

Fed Meets Next Week Under New Chair

The Fed meets next week to set monetary policy, the first meeting for incoming Fed Chair Kevin Warsh. The central bank is widely expected to keep the fed funds rate steady as it gauges how sharp and persistent the war’s impact on prices will be, and how the labor market holds up amid rising uncertainty.

In recent months, some Fed officials have become more vocal about the possibility of rate hikes later in the year, especially as the job market has held firm amid intensifying inflation concerns. The Fed’s dual mandate from Congress requires it to keep core inflation running at 2% annually while maintaining high employment.