Inflation’s Strength Raises Concerns
Swelled by surging energy costs, consumer prices climbed in March at their fastest pace in five months, the government said Wednesday. The report offered a troubling sign of accelerating inflation that could eventually stall the economic recovery.
The latest inflation data also put Federal Reserve officials into a tougher bind. Their prescription to dampen inflation -- hiking interest rates -- could damage an economy already showing signs of slowing.
“The Federal Reserve is having to walk a very fine line now, hoping to keep growth continuing but acting to keep inflation in check,” said Lynn Reaser, chief economist at Banc of America Capital Management.
Prices jumped 0.6% in March, and excluding the volatile food and energy components they still rose 0.4%, twice what analysts had predicted and the highest monthly rate of “core” inflation since August 2002. During the first three months of the year, overall consumer prices increased at an annualized pace of 4.3%. Inflation has not been that high in any full year since 1990.
The news helped send the Dow Jones industrial average down 1.1% to its lowest level since October. The Dow is down 7.2% this year.
Since June, the Fed has raised its benchmark short-term interest rate to 2.75% from 1% in hopes of keeping inflation from racing amid a growing economy. Economists, however, had been heartened by the fact that increases in prices of oil, steel, copper and other commodities had yet to dramatically raise overall consumer prices. Recent signs of a modest economic slowdown led some to hope that the Fed might be able to halt its interest rate increases soon.
But Wednesday’s report dashed those hopes.
The central bank is expected to increase rates again May 3, when its policymaking Federal Open Market Committee next meets, and to continue the increases throughout this year.
Any hint of a change in the Fed’s policy or economic view could come as early as today, when Fed Chairman Alan Greenspan is due to testify before the Senate Budget Committee.
Signs of slowing economic growth have mounted in recent weeks. Last week, the government reported disappointing growth in retail sales. Consumer confidence also has flagged, and the nation’s trade deficit has ballooned to a record.
“You have a convergence of shocks that are hitting the economy now,” said Sheryl King, senior economist at Merrill Lynch & Co. in New York. “We see the combination of higher interest rates and higher gasoline prices as cooling down the economy. The question is, how cool is it going to get?”
The Fed cut its key short-term interest rate to near zero after the dot-com bubble burst in 2000, hoping to prevent a steep recession. The drop sparked a torrid run-up in home prices and a pickup in shopping as newly flush homeowners took out home equity loans. Businesses retooled and squeezed more productivity out of workers. Last year saw economic growth of 4.4% amid stagnant wage increases and subpar job creation.
But higher interest rates and skyrocketing gasoline prices are prompting consumers to rein in their spending. The latest evidence of this came Wednesday when the Fed’s survey of economic conditions, known as the beige book, showed that, in two-thirds of U.S. regions, “retail or tourism contacts expressed concern that high energy prices were already, or could soon be, damping consumer demand.”
If rates go much higher, some fear it could kill the sizzling real estate market.
“We’re headed for real trouble,” said Dean Baker, co-director of the liberal Center for Economic and Policy Research in Washington, “because we don’t have a pattern in place to support healthy and sustainable growth.”
The twin specter of rising inflation and slowing growth might bring back painful memories of the late 1970s and early 1980s. Then, double-digit inflation and stagnant growth -- dubbed “stagflation” -- wreaked economic havoc and eroded living standards.
However, analysts say, today’s economy is stronger and inflation is far more modest.
“It’s not beyond the realm of possibility that the Fed will have to pay more attention to inflation, but believe me, this is not 1980,” said John Lonski, chief economist at Moody’s Investors Service. “Keep your disco duds in the closet.”
Optimists also contend that a slowing economy may be just what the doctor ordered for inflation. The price increases are being driven by a global bidding war for oil, copper and other commodities. Less demand will bring costs down.
“The combination of higher energy prices and higher short-term interest rates will slow the economy, but that’s what the Fed wants,” said Anthony Chan, senior economist at J.P. Morgan Asset Management.
Although acknowledging the pain for consumers, Chan said the fact that their wage increases were being outpaced by inflation boded well. “Because they’re not earning a lot more,” he said, “we’re not seeing inflation running away from us.”
Average hourly wages grew only 0.3% in March, marking the 11th straight month they have been outpaced by inflation.
Chan is due to release a study showing that when the Fed undertakes a series of interest-rate hikes to fight inflation, two out of three times the economy falls into a recession within two years.
Mark Zandi, chief economist at Economy.com, also said he thought the economy would survive its inflationary bout. He visited the Philadelphia branch of the Federal Reserve on Wednesday and was convinced that the central bank was willing to keep inching up interest rates, even if it harmed growth.
“If there is a Hobson’s choice, they’ve made it, and I think it’s the right choice,” Zandi said. “In the long run, there’s nothing more debilitating than runaway inflation.”
That point is not lost on consumers like Alesia James, whose wages are not keeping up with rising prices.
James, a 42-year-old Pasadena single mother who works as a dispatcher at KABC-TV, said she expected a 3% raise, well below the annualized inflation rate.
“Cereal’s higher now, milk’s higher,” she said. “A lot of things are higher than they need to be. I’ll get a raise next month, but it won’t compete.”
