NEW YORK (CNN/Money) -
Rising food and fuel costs lifted retail prices at the fastest pace in nearly 3-1/2 years in May, the government reported Tuesday, but the widely awaited reading on inflation was nevertheless about in line with Wall Street forecasts.
The consumer price index jumped 0.6 percent in May, the Labor Department reported, compared to a 0.2 percent rise in April. Economists surveyed by Briefing.com were forecasting a 0.5 percent gain for last month.
It was the biggest one-month gain in the CPI, the government's main inflation gauge, since January 2001.
The so-called core CPI, which excludes often volatile fuel and energy costs, edged up 0.2 percent after a 0.3 percent April increase. Briefing.com's survey had a consensus forecast of a 0.2 percent increase. The core CPI is closely watched by Federal Reserve policy-makers for signs of inflationary pressures in the economy.
The CPI reading is the last major inflation report that policy-makers will see before the Fed meets later this month to decide whether to raise interest rates.
Most economists and investors expect the central bank's policy-makers to raise their target for short-term rates on June 30, but by just a quarter percentage point.
But comments from Fed Chairman Alan Greenspan and other Fed officials in the last week promised more aggressive rate hikes if there were signs of inflation.
Tuesday's report helped dampen fears of a half-point increase by the Fed at the June meeting.
In the bond market, Treasury prices jumped after the report, pushing the yield on the 10-year bond down to 4.7 percent from 4.86 just before its release.
"The bond market went into this report looking for disaster," said Ethan Harris, chief economist for Lehman Brothers. "I think there's a sense of relief in the bond market."
On Wall Street, stocks rallied as investors hoped the Fed would be able to proceed with moderate rate hikes.
Food, energy prices up sharply
Food and beverage prices rose 0.9 percent, the department said in its report, the biggest monthly increase since 1990.
Meanwhile, energy prices soared 4.6 percent as gasoline prices hit record levels. Year-over-year food and beverage prices rose 4.0 percent, while energy prices soared 15.0 percent.
But the overall CPI posted a modest 3.1 percent gain in the last 12 months while the core CPI was up only 1.7 percent, down from the 1.8 percent rise reported a month ago.
"The key number was not the headline (overall CPI) number," said Anthony Chan, chief economist with Banc One Investment Advisors.
"Everybody knows energy prices are out of control. But to see the core number coming in line with expectations and the year-over-year figure actually declining tells me the Fed is back on plan to move at a gradual pace (of rate increases.)"
Some investors have been worried that economists had underestimated the core CPI increases for the previous four months.
That concern, coupled with last week remarks by Greenspan and other Fed officials, had caused a growing number of investors to believe that a half-point increase in short-term rates at the June 30 meeting was suddenly possible.
"After four straight months of worse-than-expected core CPI numbers, (this report provides) some relief," said Ian Shepherdson, chief U.S. economist for High Frequency Economics.
The economists told CNN/Money that Tuesday's report all but ensures there will be only a quarter-point rate increase at the June Fed meeting.
Chan said he believed that no economic report due between now and the June 30 meeting could change the Fed's thinking.