* Producer Price Index increases 1.1% in May, above

expectations for a 0.7% gain

* Goods prices, mostly energy, account for nearly 80% of the

rise in the PPI

* Wholesale goods prices excluding food and energy post

largest monthly gain since April 2022

* Weekly jobless claims increase 4,000 to 229,000

By Lucia Mutikani

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 boosted

the cost of energy products, providing more evidence that

inflation pressures were building up.

The report from the Labor Department on Thursday and

continued labor market resilience amid relatively low layoffs

reinforced economists' expectations that the Federal Reserve

would keep interest rates unchanged into 2027 and for the

Federal Open Market Committee to ditch its easing bias at next

week's policy meeting.

After oil prices retreated in recent weeks, economists had hoped

inflation would peak in May. But oil prices have resumed their

upward trend as a ceasefire frayed. President Donald Trump said

on Thursday the U.S. would hit Iran "very ‌hard tonight" and

will soon take control ​of the country's oil and ⁠gas

infrastructure and markets.

The government reported on Wednesday that consumer inflation

jumped above 4% in May for the first time in three years.

"The Fed is clearly missing its inflation target by a lot

more than it is missing its employment objective," said John

Ryding, chief economic advisor at Brean Capital. "The PPI report

should further embolden those on the FOMC who think a rate hike

might be needed later in the year."

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.

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 advanced 6.5%, the biggest gain

since November 2022. The PPI rose 5.7% year-on-year in April.

The U.S. central bank tracks the Personal Consumption

Expenditures price indexes for its 2% inflation target. The PPI

report prompted economists to upgrade their estimates for May

PCE inflation.

The conflict, now in its fourth month, 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.

A 2.8% increase in the price of goods, mostly energy

products, accounted for nearly 80% of the rise in the PPI. That

was the largest gain since the government started tracking the

series in December 2009 and followed a 1.9% advance in April.

Energy prices soared 10.7%, with the cost of gasoline

surging 23.4%. There were increases in diesel, jet fuel, plastic

resins and materials, industrial chemicals and natural gas

liquids prices. Food prices shot up 0.6%, boosted by higher

costs for fresh fruits and melons, fresh and dry vegetables,

grains and oilseeds. But wholesale pork prices dropped 10.1%.

Stocks on Wall Street were trading higher. The dollar gained

versus a basket of currencies. U.S. Treasury yields were mixed.

INFLATION IS BROADENING OUT

Excluding energy and food, goods prices rose 0.8%, the largest

increase since April 2022. The so-called core goods prices

gained 0.7% in April. A measure of core PPI, which strips out

trade services, accelerated 0.8%, also the largest advance in

just over four years. The core PPI rose 0.5% in April.

Wholesale services prices climbed 0.3% after advancing 0.7%

in April. A 4.8% surge in prices for portfolio management fees,

reflecting a stock market rally, accounted for more than 40% of

the rise in the cost of services.

But margins received by wholesalers and retailers fell,

supporting economists' views the pass-through from tariffs was

almost over. Some said refunds after the U.S. Supreme Court

struck down the duties suggested consumers would probably not

immediately see price rises as large as the producer inflation.

"But the rise in energy prices and related costs is too big for

consumers to be shielded for long," said Samuel Tombs, chief

U.S. economist at Pantheon Macroeconomics.

The cost of transporting freight by road increased 3.4%

while airline fares surged 2.5%. Hospital inpatient care prices

rose 0.5% while the cost of hotel and motel rooms accelerated

2.3%. Portfolio management fees, airline fares, hotel and motel

rooms are among the components that go into the calculation of

the core PCE price index.

Economists raised their estimates for the May PCE price index to

as high as 0.5%, after rounding, from around 0.4% earlier. The

PCE price index increased 0.4% in April. It was forecast

advancing 4.1% in the 12 months through May, up from 4.0% before

the PPI data. PCE inflation was 3.8% in April.

Monthly core PCE inflation was projected to have risen to 0.4%

after rounding, up from about 0.3% before the data and 0.2% in

April. That would translate to a year-on-year increase of 3.4%.

Core prices increased 3.3% in April.

A separate report from the Labor Department showed initial

claims for state unemployment benefits rose 4,000 to a

seasonally adjusted 229,000 for the week ended June 6.

Claims tend to rise at the start of summer as some states allow

non-teaching staff to file for unemployment benefits during the

long school holidays. Seasonal factors, the model used by the

government to strip out seasonal fluctuations from the data, do

not always capture these moves.

The economy notched a third straight month of strong employment

gains in May, the government reported last week.

Rising inflation and labor market stability have led

financial markets to price in a rate increase from the Fed. But

economists still view the bar as high for policy tightening. The

Fed is next Wednesday expected to keep its benchmark overnight

interest rate in the 3.50%-3.75% range.

"The upward pressures on inflation combined with the firming of

job gains should keep the Fed on the sidelines until 2027,

although the odds of a rate hike in 2026 are still low," said

Ben Ayers, senior economist at Nationwide.

​