CPI rose to 8.6% in May as inflationary pressures continue to strengthen

“A lot is riding on the next couple of inflation reports,” says KPMG’s Tim Mahedy, as he breaks down the key takeaways from the May CPI report.

Tim Mahedy

Tim Mahedy

Senior Director, Office of the Chief Economist, KPMG LLP

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Video summary

CPI rose to 8.6% in May as inflationary pressures continue to strengthen. “A lot is riding on the next couple of inflation reports,” says KPMG’s Tim Mahedy as he breaks down the key takeaways from the May CPI report.  


Veering off course?

The rapid pace of CPI inflation pushes Fed rate forecasts well above neutral

The May release of the Consumer Price Index has raised concerns about a potential 2023 recession as CPI inflation reached a new high of 8.6 percent year-over-year. This upward jump exceeded consensus expectations of an 8.3% rise.

While there were several contributing factors, the most concerning is that this is the second straight month and the fifth time in eight months that we have seen a 0.6% increase in core CPI inflation. To put this in context, the average monthly gain in the five-year period from 2015 through February of 2020 was 0.2%.

Another hot summer

In the early summer of 2021, new and used car prices, as well as airfare, were three key contributors to inflationary pressures. This year, the economy faces the same price pressures, as well as surges in energy and food prices – all of which are contributing to rising inflation.

As a point of comparison, last year’s airfare prices rose by 10 percent and 9 percent in April and May. This year, the gains were 19 percent and 13 percent, respectively. And, given the persistence of supply chain disruptions in the automobile and other industries, elevated prices for both new and used autos are likely to persist through the end of the year.

On the more optimistic side, airfare prices should ease at the end of the summer travel season, and energy price growth should at least slow in coming months, absent another global shock to commodity markets.  Additionally, several large retailers have already pre-announced that they are carrying too much inventory and plan significant major price markdowns in-store over the coming months. 

Time is running out for inflation to show progress

The strong May CPI release, and a jump in long-run inflation expectations caused policymakers to pivot from a 50bps hike to a more restrictive hike of 75bps at the June FOMC meeting. In the published statement, Fed officials expressed a strong commitment to bringing inflation down to the Fed’s 2 percent target, and we now expect the Fed to raise rates by 75bps in July, with an additional 50bps in September, and 25bps at the final two meetings of 2022. This would bring the federal funds rate to 3.5% by year end, a full percentage point above our estimate of neutral.

The inflationary picture is complicated, and the surge is due in part to both strong demand for some goods and services and global supply shortages. The latter is not likely to be impacted meaningfully by U.S. monetary policy. Pushing rates above neutral this year greatly increases the risk of a recession in 2023, or even the end of 2022, and could still leave inflation above the Fed’s target.

There’s still time for the next couple of inflation releases to show a significant easing in pressures. The energy sector reversed in April, pulling down headline CPI before jumping up again in May. That suggests that some of these pressures could unwind quickly, but time is running out, and the risk to both the inflation forecast and the path of interest rates remains skewed to the upside.

Key Takeaways:

  • Inflationary pressures continue to strengthen despite interest rates that are expected to rise at the fastest pace since the mid-1990s.
  • Still in play are many of the same forces that drove inflation last summer, such as elevated prices for new and used cars and pandemic-affected services. Considering that energy and food price continue to rise at a fast pace, there is an increased risk that inflation won’t ease in the next couple of months.
  • The Fed is poised to push rates well above neutral in 2022, significantly raising the risk of a recession sometime in the next 12 months.