Key inflation gauge jumps to 3-year high

The Federal Reserve's preferred inflation measure surged to a three-year high in May, driven by elevated gas prices and rising semiconductor costs fueled by the artificial intelligence buildout — a combination that threatens to upend the central bank's rate-cut plans and reshape the political landscape ahead of the midterm elections.

Consumer prices rose 4.1 percent in May from a year earlier, according to the Commerce Department's personal consumption expenditures index released Thursday. That is the largest annual increase since April 2023 and a sharp reversal from the optimism that dominated economic forecasts just six months ago, when markets were pricing in multiple rate cuts.

The monthly increase was 0.4 percent, matching April's pace. Core inflation, which excludes the volatile food and energy categories, rose 3.4 percent year over year — the largest increase since October 2023. On a monthly basis, core prices climbed 0.3 percent for the second consecutive month.

These numbers are not an anomaly. They are the latest data points in an inflation trajectory that has moved in the wrong direction for more than a year.

**What's driving the surge**

Gasoline is the most visible culprit. Average prices peaked near $4.50 per gallon nationally in May following the Iran conflict before falling back to $3.92 as of Thursday, according to AAA. But even the current level represents a more than 20 percent increase over the same time last year, and the decline since the peace deal has not been enough to offset the cumulative damage to household budgets.

Less visible but equally significant is the semiconductor price pressure driven by AI infrastructure demand. The same chips powering data centers and consumer devices are becoming more expensive as demand outstrips supply, and those costs are working their way through the supply chain. Apple last week raised prices on 14 products including Macs and iPads, explicitly citing higher component costs.

Services inflation is also running hot. Restaurant meals, hotel rooms, auto repairs, and healthcare all posted increases in May, indicating that price pressures are broad-based rather than confined to a few volatile categories.

**The Fed's deteriorating options**

The inflation data leaves the Federal Reserve with few good choices. Markets had begun the year expecting two rate cuts. Those expectations have been abandoned entirely. Some economists now believe the next Fed move could be a rate increase rather than a decrease.

Mark Vitner, chief economist at Piedmont Crescent Capital, put it bluntly: "Underlying inflation is closer to 3 percent rather than 2 percent. It does suggest to me that the next Fed move, whenever it comes, is more likely to be a hike than a cut."

New Fed Chair Kevin Warsh last week reaffirmed the central bank's commitment to its 2 percent inflation target but gave no indication of what steps the Fed might take. The silence itself was telling. After more than five years of inflation above target, the Fed's credibility depends on demonstrating it can bring prices under control — but raising rates in an election year carries its own political and economic risks.

The PCE index, which the Fed prefers over the more widely followed Consumer Price Index, puts less weight on housing and accounts for substitution effects when consumers switch to cheaper alternatives. Even with those adjustments, the picture is bleak. Inflation has not been below 2.5 percent since April 2025, when Trump unveiled his Liberation Day tariffs. It has climbed steadily since.

**The political economy of inflation**

The timing is brutal for the administration. Trump dismissed Democrats' focus on affordability as a "hoax" and told reporters he "loved the inflation" in response to the earlier CPI release. But 60 percent of Americans disapprove of his handling of the economy, according to a recent NPR/PBS/Marist poll — a lower approval rating than Biden ever received on the same metric.

The disapproval is not hard to understand. Even as inflation has declined from its 9.1 percent peak under Biden, the cumulative effect on household budgets has been devastating. Prices have not returned to pre-pandemic levels. They have merely stopped rising as fast. For most Americans, groceries still cost more, rent still costs more, and gas still costs more than they did before 2021. The fact that the rate of increase has slowed is cold comfort to a family whose real income has not kept pace.

Adding to the political pressure, Trump refused Wednesday to sign the bipartisan housing bill that cleared the Senate 85-5 and the House 358-32 — legislation intended to spur construction and lower housing costs. The refusal, tied to an unrelated demand for election-reform legislation, leaves one of the administration's most concrete affordability measures in limbo.

**The economy is growing. That's part of the problem**

A separate report Thursday showed the economy expanded at a 2.1 percent annual rate in the first quarter, upgraded from a previous estimate of 1.6 percent. Unemployment claims fell. Inflation-adjusted spending rose 0.3 percent, and real incomes increased for the first time in four months.

In normal times, these would be unambiguously positive signals. But strong demand in an inflationary environment is precisely what makes the Fed's job harder. If consumers keep spending despite higher prices, there is less downward pressure on those prices, and the central bank has less room to cut rates without risking an acceleration.

The economy is not in recession. It is not even close. But it is running too hot for the Fed's comfort, and the tools available to cool it down — primarily higher interest rates — would slow growth and increase borrowing costs for the same households already struggling with inflation.

**What this means for you**

If you are a homeowner with a mortgage, the odds of a rate cut this year are diminishing rapidly. The market has largely abandoned expectations for cuts, and some forecasters now see a rate hike as more likely than a cut. Plan your finances accordingly — refinancing opportunities may not materialize.

If you are renting, the housing bill that might have increased supply and lowered costs over time is now stalled indefinitely. Inflation in housing costs is likely to persist, particularly in markets where supply is already constrained.

If you are saving for retirement or investing, the combination of strong economic growth and persistent inflation creates a challenging environment. Bonds suffer from rising yields, and equity valuations face pressure from higher discount rates. The market turbulence this week — driven by revised rate expectations — may be a preview of sustained volatility rather than a temporary disruption.

The bottom line: inflation is not going away. It has been above the Fed's 2 percent target for over five years, and the latest data shows it is accelerating, not decelerating. The peace deal with Iran may bring gas prices down temporarily, but core inflation — the measure the Fed watches most closely — is moving in the wrong direction. For policymakers, there are no easy answers. For households, the practical advice is the same as it has been for three years: budget for higher costs, prioritize fixed-rate debt, and do not count on relief from the Federal Reserve anytime soon.