US inflation hit a three-year high in May, rising to 4.2% as fuel prices surged, according to data published Wednesday by the Labor Department. The annual rate accelerated from 3.8% in April, marking a third consecutive monthly increase.
On a monthly basis, consumer costs climbed 0.5% in May, following gains of 0.6% in April and 0.9% in March. The sharpest pressure came from energy costs.
Gasoline costs peaked and eased
Gasoline prices have already fallen since May.
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Core inflation stays relatively subdued
Core inflation, which excludes volatile food and energy categories, rose just 0.2% in May, down from 0.4% in April. On an annual basis, core prices edged up to 2.9% from 2.8%.
That suggests underlying cost pressures have not spread broadly. If energy costs continue to ease, overall price growth could begin to cool in the coming months.
Tariffs and geopolitics added to cost pressures
Price increases had been easing before President Donald Trump imposed sweeping tariffs in April 2025.
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Higher cost pressures cloud Fed rate-cut outlook
Persistently high cost pressures have shifted the debate among Fed policymakers.
At the start of the year, officials had indicated they expected to cut interest rates twice in 2026. More recently, several policymakers have suggested the central bank’s next move could be a rate increase rather than a cut. Higher interest rates generally translate into increased borrowing costs for mortgages, car loans and business lending. Investors on Wall Street currently expect the Fed to raise rates in December, according to futures market pricing tracked by CME FedWatch.
“Gasoline costs remain up almost 50% in 12 months in some states, and even if the US and Iran can come to some sort of resolution, the cost increases are increasingly looking higher for longer,” said Lindsay James, investment strategist at Quilter. She added that markets are now pricing in a quarter-point rate increase by year-end, with potential for further hikes in 2027.
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Despite rising cost pressures, the labor market has remained resilient. Hiring accelerated in May, and the economy continues to expand, reducing pressure on the Fed to lower borrowing costs to support growth. Some policymakers argue that slower growth may be necessary to bring price growth back toward the target. Yields on two-year and 10-year US Treasury bonds have risen since Friday’s stronger-than-expected jobs report, reflecting investor expectations that price growth could stay high
Fed Chair Warsh faces a difficult position
The price data also place Federal Reserve Chair Kevin Warsh in a difficult position. Warsh, who previously argued for lower interest rates and was appointed by Trump to succeed Jerome Powell, now faces renewed cost pressures that may limit the Fed’s room to ease policy. For now, Trump and White House officials have largely argued that rates do not need to rise further, rather than calling for additional cuts. Markets expect rates to remain unchanged at 3.5%–3.75% at next week’s FOMC meeting, while investors will be watching for any shifts in the Fed’s projections.
James noted that “Warsh is not a fan of forward guidance, making the future path for rates more uncertain.” The analyst added, “The US arguably has a price problem entirely of its own making, and it won’t be easy to resolve it and completely unwind the cost increases we have seen this year to date.”