Inflation in the United States accelerated again in May, driven by rising energy costs stemming from conflict in the Middle East, although a key measure of underlying price pressures rose less than expected.

Data released by the U.S. Bureau of Labor Statistics on Wednesday showed the Consumer Price Index (CPI) increased 0.5% month-over-month and 4.2% year-over-year in May, both figures aligning with market forecasts.

The 4.2% annual increase not only surpassed April's 3.8% rise but also marked the highest level since April 2023, signifying the first time in three years that the U.S. inflation rate has climbed back above 4%.

However, after excluding the volatile food and energy categories, the core CPI rose 0.2% for the month and 2.9% over the past year. While the annual core inflation matched expectations, the monthly increase was below the anticipated 0.3%, indicating that underlying inflationary pressures, while present, are heating up less than previously feared.

Soaring energy prices were the primary driver behind the overall inflation acceleration in May, with the energy index accounting for over 60% of the total CPI increase. Data shows seasonally adjusted energy inflation rose 3.9% month-over-month in May, up from 3.8% in April.

Within this category, energy commodity inflation increased 6.7% (up from 5.6%), gasoline inflation rose 7% (up from 5.4%), and fuel oil inflation climbed 3.8% (down from 5.8%). On an annual basis, energy inflation surged 23.5% in May compared to 17.9% in April, with energy commodities up 40.6%, gasoline up 40.5%, and fuel oil up a staggering 58.9%.

While the report contained some relatively mild details—such as declines in transportation services, medical insurance, and new vehicle prices—this offered little comfort to consumers. Economists anticipate further price increases ahead, which could keep the possibility of an interest rate hike this year within the policy discussion for Federal Reserve officials.

This latest inflation data is expected to reinforce the Fed's stance of keeping its policy rate elevated for a longer duration. Although the headline CPI meeting expectations and the softer-than-expected core monthly reading provided slight relief to Wall Street's concerns about the Fed's rate-hike trajectory.

Following the release of the May CPI figures, prices for gold and silver saw a brief uptick, while gains in international oil prices narrowed. Losses in the three major U.S. stock index futures also moderated, with Dow Jones futures down 0.55%, S&P 500 futures down 0.58%, and Nasdaq futures down 0.89%, after all had fallen more than 1% earlier.

Focus Shifts to Fed's Policy Stance

The CPI data released today, along with the Producer Price Index (PPI) data due tomorrow, are anticipated to influence the Federal Reserve's policy outlook. Currently, markets see almost no chance of a rate hike at the Fed's meeting next week, with the probability of a July hike slightly above 10%.

The immediate focus is on whether the Fed will signal a clear shift from an accommodative-leaning stance to a neutral or hawkish-leaning stance at its upcoming meeting. Brian Jacobsen, Chief Economist at Annex Wealth Management, noted that inflation data meeting expectations does not equate to a good report.

He stated the headline figures do not show much evidence that the surge in energy commodities is permeating into core prices. The clock is ticking loudly for the reopening of the Strait of Hormuz, whether through force or a ceasefire. The Fed will not speculate on when this might happen, so President Trump needs to provide them with certainty before their meeting.

However, there are few signs the Strait will return to normal operations soon, suggesting inflationary pressure from elevated energy costs will persist. Even if the conflict is resolved quickly, higher energy costs could linger until crude oil production normalizes.

Beyond the energy price shock, disruptions in the fertilizer market could ultimately lead to higher grocery prices, while rising transportation costs may push up prices for a wide range of consumer goods.

It is noteworthy that U.S. inflation has now exceeded wage growth for the second consecutive month, which could negatively impact overall economic growth. Mark Hamrick, Senior Economic Analyst at Bankrate, expects inflation to remain elevated in the near term due to Middle East supply chain disruptions, meaning the trend of inflation outpacing wages is likely to continue.

Economists at Zip Recruiter pointed out that wage growth falling below inflation is creating economic strain for middle-income households. The sharp rise in the cost of living undoubtedly poses a significant political burden for President Trump and his party as they seek to maintain control of Congress in the November midterm elections.

Uncertainty Over Inflation Drivers

Tiffany Wilding, an economist at PIMCO, highlighted that the key question is whether current inflation is driven by negative supply shocks or robust demand within the economy. She believes the headline data points more toward supply-side pressures, particularly the impact of Middle East developments and rising gasoline prices.

However, the core inflation data raises more questions, making the overall picture less clear. Alexander Lis, Chief Investment Officer at SD Ventures, commented that the May U.S. CPI data was largely in line with market expectations for both the headline and core measures.

While the data was not particularly strong, it was also not alarming enough to unsettle the market. He added that this was the final inflation report before the Fed's policy committee meeting this month, making the Fed's reaction the most critical factor now.

The market is about to learn whether inflation is high enough to prompt the Fed to signal a potential rate hike, a decision that could shape market movements for months to come.