US producer prices increased more than expected in May, posting their largest annual gain in three and a half years as energy costs climbed due to the conflict in the Middle East.

The Labor Department's Bureau of Labor Statistics said on Thursday that the Producer Price Index for final demand rose 1.1% in May, matching a downwardly revised increase of 1.1% in April.

Economists polled by Reuters had expected the index to rise just 0.7%, following a previously reported 1.4% jump in April.

On an annual basis, producer prices increased 6.5% in the twelve months through May, marking the largest gain since November 2022.

Most of the increase was driven by higher goods prices, particularly energy products. Goods prices rose 2.8% and accounted for roughly 80% of the overall increase in the index, while services prices advanced 0.3%.

The US-Israeli war against Iran has driven up energy product prices, including gasoline and diesel. Global supply chains have also come under pressure due to restrictions on shipping through the Strait of Hormuz, leading to shortages across a broad range of products, including fertilizers, aluminum, and consumer goods.

On Wednesday, the US government reported that consumer inflation climbed above 4% in May for the first time in three years.

The Federal Reserve monitors the Personal Consumption Expenditures (PCE) Price Index as its preferred gauge for achieving its 2% inflation target.

The acceleration in inflation, combined with a resilient labor market, has led financial markets to increase pricing for the possibility of a Federal Reserve rate hike. However, many economists still believe the likelihood of additional monetary tightening remains limited, arguing that the oil-price shock is still largely confined to the transportation sector.

The US central bank is widely expected to keep its benchmark interest rate within the 3.50%-3.75% range at next week's meeting, although policymakers are expected to abandon their previous bias toward future rate cuts.

Following the release of consumer inflation data, economists estimated that the PCE Price Index rose 0.4% in May, matching the increase recorded in April.

The annual PCE inflation rate is also expected to accelerate to 4.0% in May, the fastest pace since May 2023, compared with 3.8% in April.