US CPI still has us bracing for impact

The May CPI report was weaker than expected, bringing the annual headline increase to 2.4%, a mild tick-up from last month’s 2.3% reading. Core inflation was equally muted, with the annual rate unchanged at 2.8%, holding steady since March of this year. A combination of weaker energy prices and ongoing softness in travel demand helped weigh on prices. While the impact of tariffs on prices remains subdued so far, it is far too premature to assume that the price shock will not materialise.

Report details

• Monthly headline inflation rose 0.1% in May, lower than expected, with the annual rate accelerating slightly to 2.4%—from 2.3% previously. Core inflation, which strips out food and energy, also came in lower than expected, increasing 0.1% in May, leaving the annual rate unchanged at 2.8%. Interestingly, and somewhat counter to expectations, the administration’s trade policy has still not strongly fed through to prices so far. Nevertheless, with a recent survey from the New York Fed suggesting most firms are passing along some or all of the tariff-driven costs, the rolling impact of tariffs on prices should be increasingly felt in the months ahead.
• Food prices increased 0.3% in May, with prices for food at home also rising 0.3% as three of the six major grocery store food groups increased. Note that some food items are more vulnerable to tariff increases than others, such as fresh fruits and vegetables. As such, the impact of tariffs on prices could become more pronounced in certain food groups in the months ahead. Meanwhile, energy prices decreased by 1% in May, helped by large declines in gasoline prices, which have seen a deflationary trend since the start of the year amid weaker global crude oil prices.

• Core inflation continues to be driven mainly by services prices, which rose 0.2% on the month. Shelter was the most significant contributor to overall inflation, with owners’ equivalent rent increasing 0.3%. Ongoing softness in travel demand continued to weigh on airfares and lodging away-from-home prices, which declined by 2.7% and 0.1%, respectively.
• Core goods prices were unchanged during the month, with the full effect of the tariffs appearing mixed so far. Declines in underlying categories that are expected to be impacted the most by trade barriers, like autos and apparel, offset gains in others, like household furnishings. A front-loading of both activity at the start of the year and lingering inventory drawdown has likely contributed to a weaker pass-through effect, particularly in autos. Overall, core goods inflation remains subdued for now, however, dampening fears of pandemic-era supply chain bottleneck-induced price hikes.
• The Fed's preferred supercore inflation measure increased by 0.1%, bringing the annual rate to 2.9% from 2.7% prior. This measure excludes shelter from core services and is primarily driven by wage costs, which have steadily declined since the middle of last year alongside a softening U.S. labor market.

Policy outlook

May’s weaker-than-expected inflation report is reassuring—but only to an extent. The lack of goods inflation is a welcome sign, though this is likely to have been driven by some element of activity or inventory front-loading, which is likely to wane at some point. As a result, tariff-driven price increases may not feed through to the CPI data for a few more months yet, so it is far too premature to assume that the price shock will not materialize.

Just like other economic activity data, there is little to learn from the current inflation figures, and we’ll likely need to wait until late summer before the tariff impacts start to show through—either in corporate profit margin data or the inflation data. Similarly, while the Fed will be pleased with today’s data, with so much uncertainty still churning under the surface, the central bank will likely want to wait a bit longer before it makes any policy moves.