Monday, 25 September 2006

Slower rise in producer prices but inflation pressures remain

The Federal Reserve left interest rates unchanged after its 20 September meeting. A slower rise in producer prices in August reported last week would have reinforced expectations that inflation in the United States is on the wane. However, inflationary pressures in producer prices are still present.

Last week, in "Will US inflation persist?", I had looked at what the August manufacturing capacity utilisation figures implied for the outlook on inflation. The conclusion: With capacity utilisation still high, inflation is likely to persist around current levels for quite a while longer.

On 19 September, the US Labor Department released its report on producer prices for August. It showed that the producer price index (PPI) for finished goods edged up just 0.1 percent in August while the core index, which excludes the prices of food and energy goods, actually fell 0.4 percent.

Compared to a year ago, the finished goods PPI was 3.7 percent higher in August while the core index was just 0.9 percent higher. In July, the rates of increase were 4.2 percent and 1.3 percent respectively.

While these figures look good, other data in the report look less benign.

At the earlier stages of processing, the price index for intermediate goods rose 0.4 percent, or 8.8 percent from a year ago. Core intermediate goods prices also rose 0.4 percent, or 8.4 percent from a year ago.

While these numbers also show some moderation, they remain at relatively elevated levels. Unless they fall further soon, they are likely to serve as drags on further moderation in the inflation rate.

One thing that could lead to further falls in the inflation rate is the recent fall in oil prices. With increasing signs of a slowing economy, rising crude inventories and a reduction of threats to oil production, crude oil is now trading at around US$60 a barrel, well below its recent peak of over US$78 a barrel.

Then again, some economists say that cheaper oil means consumers can spend more on other things, possibly raising core inflation. From the Federal Reserve's perspective especially, that may be more relevant for monetary policy.

So the story that producer prices are telling is generally similar to that being told by capacity utilisation and other indicators. A slowing US economy is helping to put a cap on inflation. However, years of past monetary accommodation have resulted in the accumulation of enough inflationary pressures to keep the inflation rate elevated for a while longer.

The Federal Reserve seems to agree. In its statement following the meeting on 20 September, the Federal Reserve said that "inflation pressures seem likely to moderate over time", but "the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures" and that "some inflation risks remain".

The markets may think that the Federal Reserve is done with rate hikes, but an imminent rate cut still looks unlikely.

This week, we will get a better idea of where the US economy is heading, with plenty of economic data due to be released. Among the most watched will be those on home sales, personal consumption expenditures and its associated price index.

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