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Inflation cooled last month, thanks in part to falling gasoline prices, but the rising cost of services such as travel and restaurant meals continues to stretch people's pocketbooks.

The consumer price index for March was 5% higher than a year ago, according to a report Wednesday from the Labor Department. That's the smallest annual increase since May 2021.

Price hikes have continued to ease since hitting a four-decade high last summer, but inflation is still running more than two-and-a-half times the Federal Reserve's target of 2%.

"Inflation remains too high, although we've seen welcome signs over the past half year that inflation has moderated," Treasury Secretary Janet Yellen said this week. "Commodity prices have eased. Supply-chain snarls are being resolved. The global financial system has generally proven quite resilient."

Prices rose 0.1% between February and March. The rising cost of shelter accounts for much of that increase. Food prices were flat while energy prices fell.

The Fed will need to continue raising interest rates

The latest inflation reading comes three weeks before the Fed's next policy meeting, where officials are widely expected to raise interest rates by another quarter percentage point.

The Fed's effort to curb inflation has been complicated by turmoil in the banking industry, following the collapse of two big regional banks last month.

Since the failures of Silicon Valley Bank and Signature Bank, other lenders have grown more cautious about extending loans.

That acts like an additional brake on the economy, amplifying the Fed's own rate hikes. Fed policymakers will have to weigh the uncertain effects of those tighter credit conditions in deciding how much higher interest rates need to go.

"The Fed's job is to be more paranoid than anyone else. That's what they pay us for," said Austan Goolsbee, president of the Chicago Federal Reserve Bank, this week. "In more interesting times, like the times we're in right now, with wild shocks and financial stresses, it means we have to dig into loads of new information."

'Bizarro COVID times'

Goolsbee told the Economic Club of Chicago Tuesday that the most worrisome price hikes today are in the services sector, which was pummeled early in the pandemic and still hasn't adjusted to a rapid rebound in demand.

"The economy is still coming back from bizarro COVID times," Goolsbee said. "Goods inflation has come way down," he added. "But now services inflation, especially in the categories where spending is discretionary and was repressed for a few years — like travel, hotels, restaurants, leisure, recreation, entertainment — demand has returned and the inflation has proved particularly persistent."

Unlike housing and manufacturing, which are especially sensitive to rising interest rates, the service industries may be less responsive to the Fed's inflation-fighting moves.

"Do you care what the Fed funds rate is when you decide whether to go to the dentist?" Goolsbee asked.

One encouraging sign for the Fed is that wages — an important factor in service prices — have cooled in recent months. Average wages in March were 4.2% higher than a year ago, compared to a 4.6% annual increase in February.