Larger Gain in Core CPI Deflects Talk of Deflation

Core consumer prices in May rose at the fastest pace in nine months, according to a Labor Department report Tuesday that helped ease fears that the economy might be slipping into a deflationary spiral.

A batch of other economic statistics also released Tuesday showed that industrial production rose slightly last month and new residential construction rebounded strongly from a drop in May. However, a survey of U.S. employers indicated that few had plans to step up hiring in the upcoming third quarter.

May’s consumer price index, a closely watched measure of inflation, was flat compared with the previous month, but the core CPI rose 0.3%. That is a larger gain than had been expected and the biggest monthly increase since August, the Labor Department said. A 0.6% increase in housing and lodging costs and a 0.4% hike in medical care fueled much of the increase in the core CPI, which excludes volatile energy and food prices.

The May CPI report helped mitigate concern about the threat of deflation, a destructive, long term decline in prices. Many economists and investors have been expecting the Federal Reserve’s powerful Open Market Committee, which meets next week, to cut interest rates further in hopes of stimulating economic growth and firming prices.

There were some mixed signals coming from the battered industrial sector in May, with factory production rising 0.1% after falling in the two previous months, the Federal Reserve reported. Despite an increase in production, manufacturers remained stuck with plenty of unused capacity. In May, U.S. manufacturers were running at 74.3% capacity, unchanged from the previous month.

Housing continued to boom in May, with builders starting construction on a seasonally adjusted 1.73 million housing units, up 6.1% from the previous month, the Commerce Department reported. Housing starts in the West remained virtually unchanged, rising only 0.7%.

While residential construction activity is expected to be moderate for the rest of the year, the outlook for builders remains bright, according to a report issued by housing analyst Robert Curran at Fitch Ratings.

In light of favorable demographics and forecasted increases in consumer confidence, “housing should continue to be healthy, although slightly weaker than in 2002,” Curran said in the report.