The latest PCE inflation report delivered an unwelcome surprise, showing the Federal Reserve’s preferred measure of prices rising to its highest level in three years. The data reinforces expectations that the central bank will hold interest rates steady for now, while keeping the door open to a possible hike if inflation refuses to cool.

Breaking Down the Numbers

The Personal Consumption Expenditures index rose 4.1% in May, matching expectations and climbing from 3.8% in April. On a monthly basis, inflation ticked up 0.4%, slightly below forecasts and unchanged from April’s pace.

The more closely watched figure is “core” PCE, which strips out volatile energy and food prices, the metric the Fed favors. Core inflation rose to 3.4%, in line with expectations and up from 3.3% the month before. Month over month, it climbed to 0.3% from 0.2% in April, marking the highest reading since October 2023.

Higher energy prices have pushed overall inflation up, but the concerning part is that even setting those aside, core inflation is also rising. That signals the broadening of price pressures first seen in April carried into May.

What It Means for the Fed

For the central bank, the report complicates an already delicate balancing act. Bill Adams, chief U.S. economist for Fifth Third Commercial Bank, called the pickup in core inflation the most important takeaway, saying it adds to the likelihood of a rate increase within the next 12 months.

Even so, Adams expects the Fed to stay put when it meets in July. He suggested officials will likely want to wait and see whether inflation eases as the shocks from tariffs and the war fade.

That patience reflects where the Fed currently stands. Last week, officials signaled they intend to hold rates steady through the year, though they may be on the cusp of a single hike.

A Divided Committee

Fed Chairman Kevin Warsh made clear the central bank remains committed to returning inflation to its 2% target. While he offered no fresh guidance on policy or rates beyond the official statement, the views among his colleagues revealed notable division:

• Nine officials penciled in at least one rate hike this year.
• Six members see at least two hikes.
• Eight favor holding rates steady.

Officials expect inflation to stay elevated through the year before easing in 2027. Their projections have headline PCE ending the year at 3.6% and core PCE finishing at 3.3%.

Could the Data Already Be Stale?

One wrinkle is that the figures may already be somewhat outdated. With President Trump’s deal with Iran in place, oil prices have plunged. If the Strait of Hormuz stays open, inflation may be near its peak, even if it remains elevated for the rest of the year.

Joseph Brusuelas, chief economist at RSM, pointed to a steep 38.8% drop in West Texas Intermediate oil prices from their May high, calling it highly likely that inflation peaked in May. He anticipates a negative month-over-month reading across June’s inflation data.

But Brusuelas cautioned that core inflation won’t retreat so easily. He cited several sticky pressures, including persistent service-sector inflation, tariff-driven goods inflation, pricing pressures from the AI infrastructure buildout, and looming costs tied to defense spending. Together, he said, these factors create a challenging outlook and make it a genuinely difficult call whether the Fed should hold or hike.

Where the Forecasts Land

Other economists shared mixed but cautious views. Thomas Ryan of Capital Economics also believes core PCE likely peaked in May, as tariff effects fade and falling oil prices weigh on categories like airline fares. Still, he expects core inflation to decline only slowly from August onward, leaving the Fed with little choice but to tighten policy given the strength in economic activity and the labor market. He forecasts three rate hikes.

Markets, meanwhile, are pricing in roughly a 50% chance of a 25-basis-point hike in September. Deutsche Bank expects two hikes this year, in September and December, arguing that inflation pressures appear broad-based rather than driven by one-off factors like tariffs and energy.

Ellen Zentner, chief economic strategist for Morgan Stanley Wealth Management, summed up the mood succinctly, noting that the data serves as a reminder that inflation remains well above target.

The Bottom Line

The May PCE report underscores a persistent challenge for the Federal Reserve: inflation that is not only stubbornly above target but broadening across the economy. While plunging oil prices offer some hope that May marked the peak, the underlying core pressures suggest the fight is far from over. As the Fed weighs whether to hold steady or raise rates in the months ahead, this report ensures that talk of a rate hike will stay firmly on the table.

This article is for general informational purposes and isn’t financial advice. Anyone making decisions about investments or borrowing tied to interest rate movements may want to consult a qualified financial professional.