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Economy in Brief

by Robert Brusca Core Consumer Price Inflation Edges Lower at Producer Level …But Inflation’s Breadth is not Well-Contained  June 14, 2007

We have come to almost ignore price reports’ headlines while energy is surging. We look at the core – excluding food and energy - to get a better idea of what inflation’s trend is, and what part of it will last. For example energy prices spiked by 4.1% in the month but are up by ‘just’ 6.6% Yr/Yr. If we compounded the month’s energy rise we would find ‘inflation’ of over 61%. We know that this is false. We know that 6% is not 61 percent. We know that energy prices spurt and recede and we do not deny they have role in economics nor that the overall price level is really the most important. But that is different from inflation. Rising energy prices absorb more of a consumer’s budget and suck real spending power from the consumer and weaken the economy like a leach on a hemophiliac. But this is the MAIN short-term effect of rising energy prices WHEN the central bank is doing its job. That means that rising energy prices are contractionary first rather than inflationary.

Inflation is about the pressures that are lasting. The chart’s trend shows that those pressures actually have been dissipating even in the face of huge spikes in energy prices. For now it is reassuring. But we also look each month at inflation’s breadth. We calculate Yr/Yr rates of price increases for the overall PPI and all of its components as well as a separate tabulation for core items.

In May, while the overall core reading is in good shape with the rise of 0.2% and a Yr/.Yr gain of 1.6%, the core is showing that more categories are seeing inflation rise than fall and indeed the overall core PPI did accelerate to 1.6% from 1.5% one year ago. For consumer goods, inflation also ticked up on the month and its diffusion path is plotted against its inflation rate on a two-scale chart (see chart above). Diffusion is hovering around the mark of 50 which, as with the ISM framework, is the neutral reading. But in May the consumer goods diffusion reading is at 56.3. And that says that apart from energy and apart from food, inflation is accelerating in slightly more categories than it is falling. This is no call for despair but it acknowledges that some pressures exist despite the low core Yr/Yr rate. We saw earlier this week with import prices that pressures exist from that source. In the PPI this month the reading for core consumer goods rose by 0.3% (see tablet below); this raises the risk for the more important CPI.

PPI prices are largely well behaved in this report. But the Fed has set an ambitious goal for controlling inflation. It wants CPI inflation below 2.4% and PCE inflation below 2%, both for core measures. The PPI has no target but it’s a goods only index and refers to just domestic production. Service sector inflation tends to run hotter. So a PPI gain of 1.6% for consumer goods is really not great since consumer price inflation for services will be running closer to 3% or higher.

The inflation trends by category in the table show that consumer durables prices are on a declining trend but nondurables - excluding food and energy - are still swinging up at an uncomfortably strong pace (but not accelerating: three-months to six months). Capital goods price trends are mixed; they have accelerated Yr/Yr but their shorter sequential growth rates point lower (i.e. 3M to 6M and 6M to 12M).

For the most part the PPI is good news. But even apart from its headline there is an indicator of inflation pressures percolating. The Fed will probably be pleased that inflation was staved off so well amid rising energy prices but at the same time it will remain wary. That is how it must be with every one of these reports if inflation is to be kept in the Fed’s preferential range.

Key Trends In Producer Prices
  May-07 PPI Trends By Type Of Good
PPI 1Mo:M/M 3-Mo:ar 6-Mo:ar 1-Yr Yr-Ago
Total PPI 0.9% 11.0% 8.5% 3.9% 4.4%
  Finished Consumer Goods 1.2% 14.8% 10.9% 4.6% 5.4%
   Consumer Foods -0.2% 6.5% 12.1% 8.5% -1.5%
   Finished Consumer Goods Excl Foods 1.7% 17.9% 10.4% 3.3% 8.0%  
  Nondurable less Food 2.3% 26.4% 14.9% 4.5% 11.2%
  Consumer Nondurable excl Food & Energy 0.5% 3.1% 4.0% 2.3% 2.7%  
  Durable Goods 0.1% -1.4% -0.3% 0.5% 0.2%
Finished Core Consumer Goods 0.3% 1.0% 2.0% 1.5% 1.6%
Capital Goods 0.1% 0.3% 1.4% 1.7% 1.4%
  MFG Industries 0.2% 1.6% 2.5% 2.8% 1.8%
  Non Manufacturing  Industries 0.1% 0.0% 1.1% 1.4% 1.2%
Core PPI 0.2% 0.7% 1.8% 1.6% 1.5%
Memo: Finished Energy 4.1% 54.4% 26.9% 6.6% 20.8%
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