WASHINGTON, June 11 (Reuters) - U.S. producer prices increased more than expected in May, leading to the largest annual gain in 3-1/2 years as the Middle East conflict boosted the cost of energy products, suggesting inflation pressures were building up.
The report from the Labor Department on Thursday and continued labor market resilience amid relatively low layoffs reinforced economists' expectations that the Federal Reserve would keep interest rates unchanged into 2027 and ditch its easing bias at next week's meeting.
Inflation is likely to increase further with no end in sight to the U.S.-Israeli war with Iran, now in its fourth month. President Donald Trump said on Thursday the U.S. would hit Iran "very hard tonight" and will soon take control of the country's oil and gas infrastructure and markets.
Oil prices rose in response. The government reported on Wednesday that consumer inflation jumped above 4% in May for the first time in three years.
"The Fed is clearly missing its inflation target by a lot more than it is missing its employment objective," said John Ryding, chief economic advisor at Brean Capital. "The PPI report should further embolden those on the FOMC who think a rate hike might be needed later in the year."
The Producer Price Index for final demand advanced 1.1% last month after a downwardly revised 1.1% surge in April, the Labor Department's Bureau of Labor Statistics said.
Economists polled by Reuters had forecast the PPI climbing 0.7% after a previously reported 1.4% jump in April. In the 12 months through May, the PPI advanced 6.5%, the biggest gain since November 2022. The PPI rose 5.7% year-on-year in April.
The U.S. central bank tracks the Personal Consumption Expenditures price indexes for its 2% inflation target.
The conflict has raised prices of energy products, including gasoline and diesel. Global supply chains have been strained by the restriction of shipping in the Strait of Hormuz, causing shortages of a wide range of goods, including fertilizers, aluminum and consumer products.
A 2.8% increase in the price of goods, mostly energy products, accounted for nearly 80% of the rise in the PPI. That was the largest gain since the government started tracking the series in December 2009 and followed a 1.9% advance in April.
Energy prices soared 10.7%, with the cost of gasoline surging 23.4%. There were increases in diesel, jet fuel, plastic resins and materials, industrial chemicals, and natural gas liquids prices. Food prices shot up 0.6%, boosted by higher costs for fresh fruits and melons, grains and oilseeds. But wholesale pork prices dropped 10.1%.
INFLATION IS BROADENING OUT
Excluding energy and food, goods prices rose 0.8%, the largest increase since April 2022. The so-called core goods prices gained 0.7% in April.
Wholesale services prices climbed 0.3% after advancing 0.7% in April. A 4.8% jump in prices for portfolio management fees, reflecting a stock market rally, accounted for more than 40% of the rise in the cost of services. But the margins received by wholesalers and retailers fell, supporting economists' views the pass-through from tariffs was almost over.
The cost of transporting freight by road increased 3.4% while airline fares surged 2.5%. Prices of hospital inpatient care rose 0.5% while the cost of hotel and motel rooms accelerated 2.3%. Portfolio management fees, airline fares, hotel and motel rooms are among the components that go into the calculation of the core PCE price index.
With the PPI and CPI data in hand, economists estimated PCE inflation increased 0.4% in May after rising by the same margin in April. PCE inflation was forecast advancing 4.0% in the 12 months through May, which would be the largest increase since May 2023, after rising 3.8% in April. Core PCE inflation was projected to have risen 0.4% over the month, which would translate to a year-on-year increase of 3.4%.
A separate report from the Labor Department showed initial claims for state unemployment benefits rose 4,000 to a seasonally adjusted 229,000 for the week ended June 6.
Claims tend to rise at the start of summer as some states allow non-teaching staff to file for unemployment benefits during the long school holidays. Seasonal factors, the model used by the government to strip out seasonal fluctuations from the data, do not always capture these moves.
The economy notched a third straight month of strong employment gains in May, the government reported last week. The unemployment rate remained at 4.3%, for the third month in a row.
Rising inflation and labor market stability have led financial markets to price in a rate increase from the Fed. But economists still view the bar as high for policy tightening, arguing that the oil price shock so far remains confined to the transportation sector.
The Fed is expected to keep its benchmark overnight interest rate in the 3.50%-3.75% range at its meeting next week.
Reporting by Lucia Mutikani; Editing by Andrea Ricci
