Subdued consumer inflation in May surprises, but likely not enough for Fed

Investing.com -- With the implementation of President Trump’s aggressive tariff policy, economists were pleasantly surprised by today’s milder-than-expected CPI reading. However, overall, they don’t see it being enough to move the U.S. Federal Reserve on rates.

Today’s CPI report showed that U.S. consumer prices rose 2.4% in May from a year earlier, slightly below expectations of 2.5%, while monthly inflation slowed to 0.1%, under the 0.2% forecast, as falling gasoline prices offset shelter cost gains; core CPI matched April’s 2.8% annual pace but came in softer than expected at 0.1% month-over-month versus 0.2% expected.

Despite the subdued inflation reading, several economists warned that core PCE likely accelerated in May.

Nomura economist Aichi Amemiya noted some components of CPI that have larger weights in core PCE inflation rose notably. Additionally, PCE service components derived from PPI likely increased significantly in May.

“Although core CPI inflation surprised to the downside, prices for newspapers&magazines and prescription drug prices (both of which have a larger weight in the core PCE price index than in core CPI) rose strongly in May,” Amemiya stated. “We expect PCE core goods inflation likely remained relatively high in May, in large part due to those two components. In addition, food service inflation, which is not included in core CPI but is in the core PCE price index, came in stronger than we had expected, partially offsetting the negative impact from other components.”

Macquarie’s head economist, David Doyle, warned that core inflation will remain elevated following the implementation of tariffs.

“Despite the subdued figures, through year-end, we expect YoY core inflation to remain elevated and potentially rise as price pressures flow from recent tariff implementation,” Doyle commented.

“Overall, today’s report was a bit of a surprise,” CIBC’s Ali Jaffery said. “Our expectation is that it won’t last and core goods prices will have to start to rise. The economy will slow and that will make opportunistic pricing less pronounced than we have seen during the prior tariff episode or the pandemic, and also contain service inflation."

On the Fed, most economists agreed that nothing changes from today’s consumer inflation reading.

“At the margin, the relatively soft inflation prints over the past three months make it easier for the Fed to cut rates,” Brian Rose, Senior US Economist, UBS Global Wealth Management, said. “However, ahead of next week’s FOMC meeting, our view remains that the Fed will need to see weaker labor market data in order to resume rate cuts. Our base case calls for 100bps of cuts starting in September, but this could be delayed if payroll growth remains solid at the same time that tariffs are pushing up inflation.”

“Despite the muted impact from tariffs, it’s too early for the Fed to write off inflation risks,” Amemiya stated. “We expect today’s lower-than-expected core CPI inflation print will have little impact on the June FOMC meeting.”

"The softer pace of May inflation is good news for the Fed but it doesn’t change the calculus," Jaffery commented. "They still need to wait and see how the economy and the job market respond, where tariffs settle and what fiscal policy looks like.”

This article first appeared in Investing.com