Posted on: Sunday, May 23, 2004
Rising prices look inevitable
By Art Pine
Bloomberg News Service
Mary Jo Keffer, a high school teacher in Rockford, Ill., says she sees inflation coming back.
Gasoline now costs her $1.99 a gallon, up from $1.43 six months ago. Milk is $2.39 a gallon, up from $1.99 in November. It costs her more to eat out and to get her hair styled.
"I'm sure the cost of living is going to rise" now that the economy is getting stronger, said Keffer, 59. "Americans want everything we've always had, and we're willing to pay the price for it."
Price increases have become so prevalent, the University of Michigan's preliminary May survey of consumer sentiment showed Americans expect an inflation rate of 3.2 percent in a year, matching April's figure as the highest such forecast in nine years. In July the survey showed consumers predicted a rate of 1.7 percent in mid-2004.
So far this year, consumer prices are rising at a 4.4 percent annual rate, compared with a 3 percent increase at the same time last year. If that pace held for the entire year, inflation in 2004 would be the fastest since the 1990 rate of 6.1 percent.
"There's concern in the markets that inflation may turn out to be stronger than the Fed's models are predicting," said Gerald Lucas, chief treasury and agency debt strategist for Banc of America securities in New York.
Consumer prices rose 0.2 percent in April, the Labor Department reported May 14, reflecting higher costs for travel, healthcare and a broad range of goods and services.
For the three months ended in April, consumer prices excluding volatile food and gasoline rose at an annual rate of 3.3 percent, the fastest pace since April 1995. Prices paid by producers increased 0.7 percent, more than double what economists had expected, the department said.
Interest rate pressure
Americans' views about how rapidly inflation will rise add to pressures on the Federal Reserve to start raising its benchmark interest rate, said David Malpass, chief global economist at Bear Stearns & Co. in New York.
"Inflation expectations tend to be self-actualizing, to some extent," said Anthony M. Santomero, president of the Federal Reserve Bank of Philadelphia, in a speech May 11. "When people expect a particular rate of inflation, they tend to behave in ways that bring it about."
The Fed may be behind the curve, said William Dudley, economist for Goldman, Sachs & Co. in New York. The Fed has held its overnight bank lending rate at 1 percent, the lowest since 1958, since June and said this month it might need to begin raising the rate at a "measured" pace.
"The market is disturbed that the Federal Reserve is behind, and the Fed can't take a chance now of being wrong on this," Dudley said. "We are going to see the Fed start to tighten at the June Federal Open Market Committee meeting."
Economists' forecasts for the rest of this year and 2005 don't point to raging inflation, according to the Blue Chip Economic Indicators, which surveys 63 economists each month.
In April, the survey's consensus showed consumer prices likely to rise at 2 percent annually through the end of 2005, within the bounds of what Fed policy-makers have said they consider acceptable.
Forecasts in the latest Bloomberg News monthly survey show rates ranging from 2.1 percent to 2.3 percent through mid-2005.
"We're not going back to anywhere near the kind of inflation rate we had" in 1979, when the consumer price index rose to a 13.3 percent annual rate and the Fed induced a recession to blunt the rise of wages and prices, said Henry Kaufman, president of Henry Kaufman & Co. Inc., a Wall Street economic consulting firm.
Pressures building
Even so, the expanding U.S. economy and signs of stronger job creation suggest "inflationary pressures are building" and "growing in number," the Blue Chip Economic Indicators survey said.
Combined with slowing productivity growth, that's likely to increase unit labor costs this year, making wage costs contribute to inflation rather than help offset it, said Edward McKelvey, chief U.S. economist for Goldman Sachs.
First-quarter figures issued by the Labor Department show the rise in consumer prices has spread well beyond high-profile, often volatile items such as gasoline and food to a broad spectrum of goods and services, from medical care and college tuition to housing and recreation, said Patrick Jackman, who heads the Bureau of Labor Statistics division that puts the index together.
Core prices so far this year are increasing at a 3 percent annual pace, compared with a 0.9 percent rate in the same period last year.
"Price hikes haven't been this prevalent since the 1980s and early 1990," said William C. Dunkelberg, chief economist for the National Federation of Independent Business, a Washington-based group that represents small businesses, in a May 11 report on the group's latest survey of corporate members. "Now price hikes are pervasive in every industry."
Rising inflation may dampen consumer spending and cut into corporate profits, the International Strategy and Investment Group Inc., said in a letter to clients May 3. "Robust first-quarter earnings and the promise of more in the second are being offset by the threats of higher rates and increased inflation."
The spreading pattern of price increases is likely to heighten pressure on the Fed to raise its interest rate in June, said Roger Kubarych, a former Fed staff economist and chief U.S. analyst for Hypovereinsbank in New York.
In a statement issued just after its last meeting on May 4, the Federal Open Market Committee took a sanguine view, saying "although incoming inflation data have moved somewhat higher, long-term inflation expectations appear to have remained well contained."
Gas driving forecast
Consumers' expectations of rising inflation "has been primarily due to the rise in gasoline prices," said Richard T. Curtin, director of the University of Michigan's sentiment survey. Crude oil prices have touched all-time highs in New York as refineries process oil at near capacity to meet surging demand.
The surveys also show consumers "don't expect the increase in gasoline prices to stick," Curtin said. That means their expectations for a 3.2 percent rate a year from now reflects a belief other prices will rise more rapidly too, he said.
They may not be wrong. Continuing increases in energy prices may prompt Sherwin-Williams Co., the largest U.S. paint maker, to raise prices in the second half of 2004, said Christopher Connor, the company's chief executive officer.
"We've used a lot of productivity enhancements to try to keep our costs as low as possible," he said. "But if energy prices continue to escalate, if oil gets over $40 a barrel, we may be looking at price increases in the second half."
