Inflation in the United States has remained above the Federal Reserve's target for so long that many observers believe policymakers have tacitly accepted a higher level. The concern now is whether it will continue to rise.

Businesses, consumers, and investors could be forgiven for thinking that policymakers, despite their repeated commitment to the Fed's 2% target, are comfortable with 3% inflation.

The headline annual inflation rates of the personal consumption expenditures (PCE) and consumer price index (CPI) have exceeded the Federal Reserve’s 2% monthly target for five consecutive years. The same is true for core inflation, which excludes the more volatile costs of food and energy.

The problem will worsen before it improves. The closure of the Strait of Hormuz is putting enormous upward pressure on energy prices, from gasoline to diesel and jet fuel, pushing the US inflation rate to 4%.

Last week’s figures showed that the annual change in the PCE price index, the Fed’s preferred measure of inflation, reached 3.5% in March, its highest level in nearly three years. The 0.7 percentage point increase from the previous month was the largest in five years.

Core PCE inflation, which the Fed closely monitors, rose at a slower pace to 3.2%. But the longer energy prices remain high, the greater the likelihood that they will eventually overlap with core inflation. In this respect, policymakers have cause for concern.

Positive risks:

The Cleveland Federal Reserve’s Instant Inflation Forecasting Model currently projects a core personal consumption expenditures (PCE) rate of 3.7%, a gross PCE rate of 5.4%, and a top Consumer Price Index (CPI) rate of 6.1%—a remarkable figure. Warning signs are becoming more pronounced.

Citing the continued rise in gasoline prices, UBS economist Alan Ditemster expects top CPI inflation to reach 4.3% in May, nearly two percentage points higher than the 2.4% recorded in February, just before the Iran-Iraq War. This would be one of the largest three-month CPI changes in decades.

Ditemster estimates that the three-month top CPI will reach 8.51% in May, the fifth-highest level since 1982, excluding the pandemic-stricken years of 2021-2022.