May US CPI inflation hits 12-year high: Don't panic!

May Consumer Price Index (CPI) growth jumped to 4.9 percent year-over-year*, the highest rate seen in nearly 13 years. However, there is a significant base effect that is distorting this 12 month inflation rate. The sharp drop in price levels in March, April and May of 2020, which resulted from the sudden halt of economic activity, yield an artificially high year-over-year inflation rate. To get a better sense of how fast prices were rising in May, it’s better to look at the month-over-month inflation rate. Month-over-month CPI inflation slowed to 0.6 percent in May from 0.8 percent in April, and Core CPI, which excludes volatile food and energy prices, slowed to 0.7 percent vs. 0.9 percent in April. While a single month’s data does not constitute a trend, these lower numbers do suggest that fears about runaway inflation may be overdone.

However, inflation rates are likely to remain elevated in the near term as significant mismatches in supply and demand endure. In addition to supply chain disruptions in several industries, these distortions are also being driven by a large pivot in consumer spending patterns over the last year. Spending on goods is up 19% from just before the pandemic while spending on services is still down 5%. As the economy continues to reopen, spending on services, especially in-person services, will rise and crowd out spending on goods – helping to alleviate the supply-demand disconnect for many products and moderate price spikes. While this pivot to services will also yield its own inflationary pressures that will take time to process, the disequilibrium seen in this part of the economy will also gradually dissipate. As this occurs inflation will continue to moderate and return to a rate more acceptable to the Federal Reserve. 

* On a seasonally adjusted basis