One dollar bill

US inflation picks up in May

Inflation accelerated again in May, with the headline consumer price index (CPI) rising by 1% month on month, following a more modest 0.3% rise in April. In year-on-year terms, CPI was up by 8.6% in May—a 40-year high. Core inflation, a measure that strips out more volatile food and energy prices, was up by 6% year on year—three times the target of the Federal Reserve (Fed, the central bank).

Why does it matter?

Inflation in May was higher than expected; market consensus estimates had pointed to an increase of just 0.7% (which in itself would have been a high reading). This renewed jump in prices will create volatility in stockmarkets. US asset prices fell for six consecutive weeks in April-May, largely reflecting investors’ concerns that surging inflation would prompt the Fed to tighten monetary policy even more aggressively. Stockmarket losses halted in late May after a spate of softer economic data—including signs that inflation had plateaued in April—suggested that the Fed would be able to maintain its more dovish approach. However, the record May inflation figure will stoke market concerns and cause asset prices to fall further, at least until the Fed clarifies its strategy at its June 14th-15th meeting.  

For now, we expect the Fed to stick to the moderate pace of tightening that it outlined last month, which should tame market volatility in the second half of June. Inflation of 1% month on month in May was huge, but not wholly surprising (we had expected an increase of 0.8%). Energy was the main contributor, which was expected after US petrol and other energy prices started rising again after a brief respite in April. The energy commodities sub-index jumped by 4.5% compared with April, while energy services (including electricity and piped gas) increased by 3%. Higher energy costs trickled into several other areas, most notably airline fares, which rose by 12.6% compared with April and were up by nearly 38% compared with the same point last year. Nevertheless, inflation was broad based, encompassing most goods and services categories and reflecting the impact of both external events (notably the war in Ukraine) and domestic demand. 

What next?

We expect inflation to remain high in year-on-year terms in the summer, before starting to ease from September as energy prices plateau (albeit at record levels) and domestic demand starts to soften. This should allow the Fed to maintain its current, moderate pace of tightening (we expect the federal funds rate to peak at 3-3.25% in March 2023). If inflation does not abate as we expect, this increases the likelihood that the Fed will tighten more aggressively and the US economy could fall into recession.

More award-winning insights on the economic outlook for the US can be found in EIU Viewpoint, our new analysis service. EIU Viewpoint provides unmatched forecasts, analysis and data for nearly 200 countries and six key industries, helping organisations identify prospective opportunities and potential risks.