Producer prices jump 6.5% in May, fastest annual gain since 2022

US producer prices rose 6.5% in May from a year earlier, the fastest pace in 3 1/2 years, as the Iran conflict drove energy costs higher and complicated the Federal Reserve's rate path.

"Overall, this report may be slightly comforting for the Federal Reserve, given milder core inflation. But it's not too late for high energy prices to spread into the rest of the index," said Preston Caldwell, senior US economist at Morningstar.

Month over month, the producer price index jumped 1.1%, topping expectations. Goods prices surged 2.8%, led by gasoline, while services rose a more modest 0.3%. The annual reading of 6.5% exceeded the 6.4% consensus forecast and accelerated from April's 6% pace. Core CPI, a separate measure of consumer inflation that strips out food and energy, rose 2.9% annually, matching estimates.

The data complicates the outlook for the Federal Reserve, which meets next week for its first rate decision under new Chair Kevin Warsh. Markets now price 66.1% odds of a rate hike by December, according to CME Group's FedWatch tool, up from near-zero at the start of the year. The May jobs report — which showed 172,000 nonfarm payrolls added, well above the 105,000 estimate — has already reduced the case for easing.

Energy Costs Drive the Surge

The PPI increase was concentrated in goods, where energy costs pushed the monthly gain to 2.8%. Gasoline prices alone rose 7% month over month and nearly 59% from a year earlier, the Bureau of Labor Statistics reported. The energy index accounted for more than 60% of all consumer price increases in May, according to CPI data released earlier this week.

The transmission from producer to consumer prices remains the central concern for policymakers. "For now, core inflation readings are reassuring," said Don Rissmiller, chief economist at Strategas. "It is still possible, if the Strait of Hormuz opens fully, that this inflation will be 'transitory.' But US monetary policymakers will almost certainly want to see data supporting that view before relying on such an outcome."

The last time producer prices ran this hot was November 2022, when the annual PPI hit 7.1% before beginning a steady descent. That disinflationary trend reversed this year after the US and Israel launched attacks on Iran in late February, disrupting oil flows through the Strait of Hormuz. Brent crude has traded above $90 a barrel for most of the period, feeding through to gasoline prices at the pump.

Consumer sentiment has deteriorated sharply. The University of Michigan's May survey showed Americans' views on the economy dropped to an all-time low, with survey director Joanne Hsu saying consumers felt "buffeted by cost pressures, led by soaring prices at the pump."

The Fed's response will depend on whether the energy shock remains contained. "We'd need many more months of favorable data, along with a definitive resolution for the Iran war, to rule out rate hikes in the next 12 months," Caldwell said. The next PPI release is scheduled for July 15, with the Fed's June meeting set for next week.

This article is for informational purposes only and does not constitute investment advice.