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Oil could be setting an inflation time bomb for autumn

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With oil prices back above $73 a barrel, anyone who regularly fills a gas tank has to be hoping that this isn’t the start of a new surge.

Carl Weinberg, chief economist at High Frequency Economics, says there’s a reason beyond the personal pocketbook issue to worry about another jump in oil prices: The effect on inflation gauges worldwide.

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Although crude is up from $34 a barrel in December, it’s still far below its peak prices of a year ago, when it topped out at $145 a barrel on July 3, 2008. The year-over-year drop has continued to put downward pressure on the U.S. Consumer Price Index and other inflation measures around the globe.

In July, for example, the energy component of the CPI was down 28% from a year earlier. That pulled the overall CPI down 2.1% -- the biggest 12-month drop since 1950 -- even though many other costs have continued to rise despite the recession.

Oil’s drop more than offset the 3.2% year-over-year increase in medical care costs, and the 1.1% rise in food and beverage costs.

But oil’s beneficial effect on the CPI stands to end this fall, because crude and other commodities began to collapse last September amid the financial-system meltdown.

Oil fell from $115 a barrel at the end of last August to $100 by the end of September, $68 by the end of October and $54 by Nov. 30.

Now, if the price stays at $73 or goes higher, and gasoline follows suit, energy prices will begin to put upward pressure on the CPI by October.

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‘While the pass-through of higher oil prices into consumer prices may be less than 100%, no one should treat the risk of a substantial increase in perceived inflation by year-end as anything but a serious threat to both consumer demand and to economic growth,’ Weinberg wrote in a report this week.

He worries that, if financial markets believe that inflation is gaining traction, long-term interest rates could rise sharply, threatening to abort any economic recovery.

In theory, markets shouldn’t be fooled: They know enough to look at the ‘core’ inflation rate (CPI excluding food and energy costs) as well as the ‘headline’ number of the overall index.

But what Weinberg fears is that a rising headline number, because of oil, might create its own reality, and could even drive central banks to begin tightening credit in the face of a still dangerously weak economy.

I suppose it could happen. But I think most people would prefer that oil prices stay down for the obvious reason: Higher gasoline prices are a financial drain that most struggling consumers just can’t afford.

-- Tom Petruno

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