WRAPUP 2-US consumer sentiment slumps, households brace for inflation surge

By Lucia Mutikani

WASHINGTON, May 16 (Reuters) - U.S. consumer sentiment deteriorated further in May, with one-year inflation expectations soaring to levels last seen in late 1981 amid escalating fears over the economic impact of President Donald Trump's trade policy.

The University of Michigan's Surveys of Consumers on Friday showed a significant decline in morale among Republicans, suggesting that even Trump's base was becoming concerned with the president's sweeping tariffs, which this week led retail giant Walmart to warn that it would start raising prices at the end of month because of increased costs from import duties.

It was the first time that sentiment dropped among Republicans since Trump's November 5 electoral victory. The continued slump in overall sentiment and jump in inflation expectations suggested a retrenchment in consumer spending was probably underway that could temper economists' expectations for a rebound in economic growth this quarter.

The economy contracted in the first quarter for the first time in three years amid a flood of imports as businesses tried to beat the higher costs associated with tariffs. Retail sales were almost flat in April.

"The consumer is plainly worried and reading between the lines it is not just price increases that are worrying, it is the fact that many goods may be impossible to find as the reduction in port activity means shortages could develop within months," said Christopher Rupkey, chief economist at FWDBONDS.

"The outlook continues to darken and one wonders how long this can continue before the economy actually slips over the edge into recession."

The University of Michigan's consumer sentiment index dropped to 50.8 this month, the lowest level since June 2022, from a final reading of 52.2 in April. Economists polled by Reuters had forecast the index would rise to 53.4.

Sentiment dropped 7% among Republicans, offsetting an improvement among independents. The mood remained gloomy among Democrats.

The survey was conducted between April 22 and May 13, wrapping up two days after the U.S. and China de-escalated their trade war. Duties on Chinese imports were slashed to 30% from 145% for 90 days as part of the deal reached last weekend by Washington and Beijing.

The University of Michigan said the initial reaction mirrored the minor improvement in sentiment seen following the delayed implementation in April of Trump's country-specific duties until July.

"Tariffs were spontaneously mentioned by nearly three-quarters of consumers, up from almost 60% in April; uncertainty over trade policy continues to dominate consumers' thinking about the economy," said Joanne Hsu, the Surveys of Consumers director. "Consumers continue to express somber views about the economy."

Consumers' 12-month inflation expectation soared to 7.3%, the highest level since November 1981, from 6.5% in April. Both Democrats and Republicans anticipated higher near-term inflation. The jump pointed to higher prices in the months ahead despite benign consumer prices in April, which economists attributed to businesses still selling inventory accumulated ahead of tariffs.

PRICE HIKES LOOMING

Auto manufacturers also have announced price increases, and economists expect inflation to pick up by the middle of this year. Long-run inflation expectations increased to 4.6% in the University of Michigan data, the highest level since March 1991, from 4.4% in April amid a large jump among Republicans. Rising inflation expectations could complicate matters for the Federal Reserve as it weighs its next monetary policy move.

"The key idea to remember here is that inflation expectations are the primary transmission mechanism, along with external retaliation, that turns tariffs into a sustained increase in the price level or inflation," said Joseph Brusuelas, chief economist at RMS US. "The idea that the Federal Reserve is going to hike rates anytime soon should be summarily dismissed."

Fed Chair Jerome Powell warned on Thursday that "we may be entering a period of more frequent, and potentially more persistent, supply shocks - a difficult challenge for the economy and for central banks. The U.S. central bank left its benchmark overnight interest rate in the 4.25%-4.50% range earlier this month.

Higher inflation was flagged in a separate report from the Labor Department's Bureau of Labor Statistics that showed prices for imported capital goods jumped 0.6% in April, while those of consumer goods excluding motor vehicles increased 0.3%. Overall import prices, which exclude tariffs, gained 0.1% after falling 0.4% in March. The reading confounded economists' expectations for a 0.4% decline.

"Our tariff pass-through analysis indicates that costs are still largely being borne by U.S. importers," said Pooja Sriram, an economist at Barclays. That is at odds with the White House's narrative.

Tariffs are also weighing on activity in the housing market.

A separate report from the Commerce Department's Census Bureau showed single-family housing starts, which account for the bulk of homebuilding, dropped 2.1% to a seasonally adjusted annual rate of 927,000 units last month, the lowest level in nine months. Permits for future construction of single-family housing declined 5.1% to a rate of 922,000 units, suggesting the weakness might persist. There is also a glut of unsold new homes on the market.

Indeed, a National Association of Home Builders survey on Thursday showed sentiment among single-family homebuilders plunged to a 1-1/2-year low in May, with 78% of builders reporting "difficulties pricing their homes recently due to uncertainty around material prices."

"Builders are hitting the brakes this year in response to high uncertainty for costs and future demand," said Ben Ayers, a senior economist at Nationwide. "We expect starts to fade further over the summer as conditions remain challenging for builder profitability."