Americans' inflation expectations jumped to another 11-year high in May, New York Fed says

U.S. consumers ratcheted up their outlook for where inflation will be one year from now, according to a key Federal Reserve Bank of New York survey published Monday, a potentially worrisome sign for the central bank as it tries to tame white-hot prices.

The median expectation is that the inflation rate will be up 6.6% one year from now, matching an 11-year-high recorded in March, according to the New York Federal Reserve's Survey of Consumer Expectations, which dates back to 2013. Three years from now, consumers see inflation hitting 3.9% – unchanged from last month.

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"Median inflation uncertainty — or the uncertainty expressed regarding future inflation outcomes — retreated at the short-term horizon from a series high in May," the report said. "In contrast, median inflation uncertainty increased to a new series high at the medium-term horizon."

Although consumers lifted their expectations for inflation over the next year, they believe that things like food, medical care, rent and tuition will fall over the next year. But they expect that gas prices – which have climbed consecutively higher over the past month, hitting a national average of $5 per gallon for the first time ever – to continue to rise. 

The report is based on a rotating panel of 1,300 households.

The survey plays a critical role in determining how Fed policymakers respond to the inflation spike. That's because actual inflation depends, at least in part, on what consumers think it will be. It's a sort of self-fulfilling prophecy – if everyone expects prices to rise by 3% in the year, that signals to businesses that they can increase prices by at least 3%. Workers, in turn, will want a 3% pay raise to offset the rising costs.

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"The risk is rising that an extended period of high inflation could push longer-term expectations uncomfortably higher," Fed Chairman Jerome Powell said recently.

The new projections come on the heels of a scorching-hot Labor Department report that showed the consumer price index, a broad measure of the price for everyday goods, including gasoline, groceries and rents, rose 8.6% in May from a year ago, faster than expected. Prices jumped 1% in the one-month period from April. 

It marks the fastest pace of inflation since December 1981.  

The inflation report jolted the Fed just a few days before its June policy-setting meeting. Central bank officials had already taken the most aggressive approach in years to taming inflation, lifting the benchmark interest rate by 50-basis points in May and all but promising that similarly sized hikes were coming in June and July. 

The worse-than-expected reading solidified expectations that the Fed will keep raising rates at that pace through September, and has raised the odds among traders that central bankers will approve a mega-sized, 75-basis point hike unless prices moderate. 

The biggest question now is whether central bank officials can successfully tame inflation and stabilize prices without triggering an economic recession. Raising the federal funds rate tends to create higher rates on consumers and business loans, which slows the economy by forcing them to cut back on spending.

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"The Federal Reserve's job gets more challenging by the day with inflation at a new 40-year high, coupled with a broader weakening of the economy," said Danielle DiMartino Booth, CEO of Quill Intelligence and a former Fed adviser. "The Federal Reserve is tightening policy into a recession."