Inflation Rose 4% in May. Will the Federal Reserve Raise Interest Rates?

Inflation has been a problem for consumers since mid-2021. Over the past two years, many people have been forced to raid their savings accounts and rack up debt just to keep up with higher living costs

In June of 2022, the Consumer Price Index (CPI) peaked at 9.1% on an annual basis. Since then, inflation levels have steadily declined. And in May, the CPI came in at 4% on an annual basis, which is clearly a major improvement from roughly a year ago. On a monthly basis, the index rose just 0.1%.

But still, May's CPI reading is a ways off from the 2% rate of inflation the Federal Reserve is looking to attain. And so it's unclear as to whether 4% inflation will be enough to get the Fed to hit the brakes on interest rate hikes.

The Fed might still raise interest rates

The Federal Reserve is committed to keeping inflation at or around 2% because the central bank feels that this level is most conducive to long-term economic stability. In fact, the whole reason the Fed has been persistent with its interest rate hikes is that it wants inflation to cool so that consumers can get relief and so that the U.S. economy can thrive.

Unfortunately, though, the Fed's interest rate hikes have driven up the cost of borrowing across the board. These days, it's more expensive to borrow money in just about any shape or form, whether it's a personal loan, auto loan, or home equity loan.

May's CPI reading represents nice progress on the Fed's mission to cool inflation. But 4% inflation is still not really close to 2%. And so it's unclear as to whether the Fed will opt to move forward with another modest interest rate hike in light of this news or pause rate hikes for the time being.

Recession avoidance is another concern

The Fed's goal has always been to raise interest rates enough to get consumers to reduce their spending, but not so much as to cause a massive pullback in spending. The latter scenario has the potential to lead to a recession, and the Fed doesn't want that. What it wants instead is what it calls a "soft landing" -- that sweet spot where consumer spending declines and helps inflation diminish without causing a broad economic slowdown.

Still, the Fed is well aware that its rate hikes have the potential to fuel a recession. The central bank has even warned consumers to gear up for a downturn during the latter part of 2023, albeit a mild one. And the moves the Fed makes in the near term could easily tip the scales one way or the other.

All told, 4% inflation is definitely an improvement over the numbers we've seen over the past year. Whether it's enough to get the Fed to pump the brakes on interest rate hikes is questionable, so it'll be interesting to see what the central bank decides to do at its upcoming meeting.