Inflation surged to its highest rate in over three years, catapulted by rising energy costs that are increasingly squeezing American households.

• The silver lining: The pain is not bleeding through to inflation in other goods and services.

Why it matters: At least for now, this does not look like the broad-based inflation that defined the post-pandemic surge. Instead, consumers are absorbing the fallout from the Iran war mostly through higher gasoline and energy bills.

• Even if the energy shock remains contained, it lands atop years of cumulative price increases that have left consumers particularly sensitive to rising costs.
• Meanwhile, other inflation risks — from tariffs, AI-related investment or a more prolonged war — simmer in the background.

What they're saying: "Inflation pressures were muted in May outside areas directly impacted by the jump in energy prices," Pantheon Macro economist Sam Tombs wrote in a note.

• There is "no sign of second-round effects from the surge in energy prices" that would push the Federal Reserve to raise interest rates, Tombs added.

Driving the news: Consumer prices rose 0.5% last month and 4.2% in the year ending in May — the highest annual inflation rate since April 2023.

• Energy prices accounted for more than 60% of the monthly increase in inflation, according to the Bureau of Labor Statistics, with gasoline prices jumping 7% in May alone. Gas prices are now up more than 40% from a year ago.
• Core inflation, which excludes food and energy, rose just 0.2% for the month and 2.9% in the 12 months ending in May.
• On a three-month annualized basis, core prices increased at roughly a 3.2% pace in May — still above the Fed's 2% inflation target but roughly in step with April.

Between the lines: Food inflation slowed, shelter eased and motor vehicle insurance declined — signs that the energy shock has not yet become broad-based.

• Airline fares were a notable exception, rising 2.7% in May.

The intrigue: The 1.3 percentage-point gap between headline and core inflation is the widest since late 2022, a sharp reversal from the inflation dynamic that prevailed after the energy shock caused by Russia's invasion of Ukraine began to fade.

• At its most extreme, in June 2023, core inflation exceeded headline inflation by nearly 1.8 percentage points as housing and service-sector inflation remained stubborn even as energy prices cooled.

Friction point: Real hourly earnings for rank-and-file employees fell 0.8% from a year earlier in May, continuing a sharp reversal from recent years when wage gains generally outpaced inflation and helped support consumer spending.

The bottom line: The distinction between headline and core inflation often matters little for American consumers, with higher prices at the gas pump a potent source of economic and political frustration.

• For Fed officials, the report offers some reassurance beneath the ugly headline. With inflation back above 4%, however, the stakes are high if surging costs begin spilling over.

Two of the world's most important central banks appear poised to raise interest rates in the coming days, as policymakers look to get ahead of the energy price surge translating into broader inflation.

Driving the news: The European Central Bank's policy committee meets tomorrow and is expected to raise its main deposit rate to 2.25%, from 2%, which would be its first rate increase in three years.

• The main event will be president Christine Lagarde's press conference, which could give hints as to whether the increase is a one-and-done rate adjustment or if more tightening is likely this year.
• Next week, the Bank of Japan meets and is expected to raise its policy rate to 1%, the highest since 1995. It may also accelerate its quantitative tightening program of shrinking its massive balance sheet.

State of play: The common thread for both the eurozone and Japanese economies is that they are taking the brunt of the energy price surge on the chin, yet economic activity has proven strikingly resilient.

• That raises the risk that the oil price shock could spread through their economies to cause broader inflation, which the coming rate adjustments are meant to head off.

What they're saying: "Markets are increasingly concerned that the BoJ is behind the curve," wrote Ayako Fujita, an economist at JPMorgan.

• "The BoJ will likely try to deliver a hawkish message to alleviate these concerns," perhaps mentioning the possibility of additional rate hikes.

Of note: Governor Kazuo Ueda will miss the meeting, the bank said, as he is expected to be hospitalized for about two weeks to treat an infection. His deputy will act as chair.

Zoom out: The Federal Reserve will be the next major central bank on tap, with its first policy meeting under chair Kevin Warsh set to conclude a week from today.

• The Fed is likely to keep interest rates unchanged for now.