Muted May Inflation Data Suggests Tariff Impact Yet to Take Effect

Key Takeaways

• Inflation was cooler than expected in May, with prices rising 2.4% on an annual basis.
• The impact of President Donald Trump’s new tariffs was more muted in the data compared with what economists expected.
• Prices for new and used cars fell in May, along with prices for airline fares and clothes.
• Morningstar expects the first Fed rate cut to come in July.

Inflation was more muted than economists expected in May, a sign that the full impact of President Donald Trump’s new tariffs has not yet permeated the US economy.

Inflation overall rose at a 2.4% annual rate in May and 0.1% on a monthly basis, according to data released Wednesday by the Bureau of Labor Statistics. Core inflation, which excludes volatile food and energy prices, rose 2.8% on an annual basis and 0.1% on a monthly basis.

For months, investors, businesses, and consumers have been bracing for higher costs and prices associated with the aggressive new trade policy in Washington. So far, those dramatic effects have yet to materialize in the data, despite declining consumer and business sentiment and anecdotal data from companies that say they plan to pass some tariff costs on to consumers.

“Inflation is running cool again, with very little impact from tariffs so far,” says Preston Caldwell, Morningstar’s senior US economist. It’s good news for the Federal Reserve, which has been working for the better part of three years to bring inflation (which peaked in the summer of 2022) back down to target levels. Caldwell points out that 0.13% core inflation in May translates to three-month annualized growth in core inflation of 1.2%-1.4%, as measured by the Personal Consumption Expenditures Price Index (the central bank’s preferred indicator). That’s “comfortably under the Fed’s 2% target,” Caldwell says.

The outstanding question, of course, is how much tariffs will change the picture in the months ahead. It’s widely agreed that the new import taxes will put upward pressure on inflation, but it’s still not clear how dramatic or lasting that impact will be.

Tariff Impact Muted

Overall, Caldwell says, “the data shows that almost none of the cost of tariffs has been passed on to consumers so far.” Core goods prices were flat in May, he says, which is consistent with 2% inflation in a normal environment.

He points to new-car prices, which fell by 0.3% in May. “The lack of tariff impact there is not surprising, given major auto manufacturers have been slow to implement price hikes,” Caldwell says. Used-car prices also dropped 0.5%, however. That’s “despite reports of heightened demand as consumers attempt to front-run the tariff impact, as well as the fact that used prices tend to be more responsive to market conditions than new prices.”

Caldwell concludes: “It also seems to be the case that the underlying trend in inflation, excluding any tariff impact, is heading down again.” He points out that shelter costs, which drove inflation higher for most of the last two years, rose a “mild” 0.25% in May, while services costs excluding shelter ticked up 0.2%. Airline fares and gasoline prices also fell.

May CPI Report Key Stats

• CPI rose 0.1% for the month after rising 0.2% in April.
• Core CPI also rose 0.1% after rising 0.2% in April.
• CPI increased 2.4% year over year after increasing 2.3% the prior month.
• Core CPI rose 2.8% from year-ago levels after remaining unchanged in April.

Minor Signs of Pressure

“If you squint at the data,” Caldwell says, there are some signs of early tariff impacts. Toy prices jumped 1.3% in May, he says, while durable goods prices (excluding cars) were 0.2% higher. On the other hand, clothes prices fell 0.4% for the month.

Caldwell infers that right now, US importers and not consumers are likely feeling the brunt of the tariffs. The US dollar has not strengthened, and import prices excluding tariffs haven’t fallen. But that balance is likely to change. “These companies can’t shoulder this burden forever,” Caldwell says, “which still strongly suggests that consumer price inflation is going to tick up in coming months.”

Will the Fed Cut Sooner?

The central bank has held interest rates at their current range of 4.25%-4.50% since last December, amid sticky inflation and uncertainty about how Trump administration policies like tariffs could affect inflation. Analysts say that with the labor market holding, the Fed has some wiggle room to keep rates steady for now.

On the whole, analysts don’t expect Wednesday’s benign data to change the picture for the Fed when it meets later this month. “The Fed might be tempted to jump on today’s data to cut in its upcoming meeting, but we still expect them to wait for more data before reacting,” Caldwell says. He expects the next interest rate cut to come in July, and anticipates two cuts in total this year.

Bond futures traders now see an 16% chance of a rate cut in July, according to the CME FedWatch Tool, down from 28% odds last week. They see 55% odds that the Fed cuts in September.