WASHINGTON, June 11 (Reuters) - U.S. producer prices increased more than expected in May, leading to the largest annual gain in 3-1/2 years as the Middle East conflict drove up the cost of energy products.

The Producer Price Index for final demand advanced 1.1% last month after a downwardly revised 1.1% surge in April, the Labor Department's Bureau of Labor Statistics said on Thursday.

Economists polled by Reuters had forecast the PPI climbing 0.7% after a previously reported 1.4% jump in April. In the 12 months through May, the PPI increased 6.5%, the biggest rise since November 2022. A 2.8% increase in the price of goods, mostly energy products, accounted for nearly 80% of the rise in the PPI. Prices for services gained 0.3%.

The U.S.-Israeli war with Iran has raised prices of energy products, including gasoline and diesel. Global supply chains have been strained by the restriction of shipping in the Strait of Hormuz, causing shortages of a wide range of goods, including fertilizers, aluminum and consumer products.

The government reported on Wednesday that consumer inflation jumped above 4% in May for the first time in three years.

The U.S. central bank tracks the Personal Consumption Expenditures price indexes for its 2% inflation target.

Rising inflation together with labor market stability have led financial markets to price in a rate increase from the Federal Reserve. But economists view the bar as high for policy tightening, arguing that the oil price shock so far remains confined to the transportation sector. The U.S. central bank is expected to keep its benchmark overnight interest rates in the 3.50%-3.75% range at its meeting next week. Economists, however, expect the Fed will abandon its easing bias.

Following the CPI report, economists estimated PCE inflation could increase 0.4% in May after rising by the same margin in April. PCE inflation was forecast advancing 4.0% in the 12 months through May, which would be the largest increase since May 2023, after rising 3.8% in April.