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|  | APRIL 20, 2005
By Michael Englund Inflation's Seasonal ItchThe scary March CPI numbers reveal an economic pattern also seen in spring, 2004. So don't expect the Fed to crank up the rate hikesWell, investors can't say they weren't warned. The Federal Reserve policymakers' Mar. 22 statement said "pressures on inflation have picked up in recent months." And the clearest possible indication of that is the consumer price index for March, released Apr. 20. The month's overall CPI jumped 0.6%, higher than economists' median forecast of a 0.5% gain, while the core index, which excludes volatile food and energy prices, increased 0.4%, vs. the median forecast of 0.2%. The monthly gain left the overall index rising at 3.1%, year-over-year, compared to 3% in February, while the core index still managed to moderate to 2.3% year-over-year growth from 2.4% in February. As anyone who has pulled up to a gas pump recently could guess, energy led the increase in the overall index with a 4% gain in March, as gasoline jumped 7.9%. The core index was led by a 0.6% gain in shelter, a 0.8% jump in apparel, a 0.5% rise in medical care, and a 0.8% jump in tobacco. BEEN HERE BEFORE. Rising U.S. inflation, as highlighted by the March core CPI data, and seemingly unsustainable strength in U.S. economic growth the past year, has prompted fears of an interest rate-led economic retrenchment in 2005. The CPI report exacerbates recent concerns that the U.S. economy might be headed for a "soft patch," as the stronger price gains imply greater "real" (i.e., adjusted for inflation) weakness in the March spending data. Accordingly, we at Action Economics have knocked down our first-quarter GDP growth estimate to 3.3%, given likely stronger price gains. But if this feels like "deja vu all over again," there's a good reason. At Action Economics we continue to expect the "soft patch" for the U.S. economy to parallel its path in 2004. Indeed, the expression "soft patch" was coined by Fed Chairman Alan Greenspan in July of last year to diminish market fears about the economy, as he correctly viewed a slowdown in spending in the 2004 second quarter as a reflection of temporary price gyrations that would be reversed. The bulk of the early 2004 inflation surge was seen in gasoline prices, as is evident in 2005 as well. Strength in gas prices early last year reflected the combination of upside surprises in U.S. economic data and strong global economic growth in general, particularly in China. The same could be said for early 2005 -- including the upside surprise in China's gross domestic product data released on Apr. 19. BOUNCE-BACK COMING? We also attribute price strength in 2004's first quarter to seasonal strength that we believe is repeating itself in 2005. The same pattern is apparent in the most recent core CPI data, showing that the seasonal story is far from being all about oil -- especially given the higher-than-expected rise in the core figure for March. As with 2004, we see a recycled soft patch reflecting a substitution of quantity for price that will prove partly self-correcting, as seasonal and oil-led price increases at least partly subside. Nominal (unadjusted for inflation) spending remains solid, and real growth should bounce back once seasonal price strength moderates. In total, the first quarter's sharp swing in market perceptions toward fears of surprisingly strong U.S. economic growth, surprisingly strong U.S. inflation data, and surprisingly robust global demand for oil has prompted upward revisions in market forecasts for the pace of Fed tightening. The result has been a race by analysts to now revise downward their forecasts for global economic growth. In the near term there's a risk of further strength in the CPI report again in April, given trends in energy prices. However, at Action Economics, we continue to forecast a steady stream of quarter-point rate hikes through the year, with the Fed funds reaching 4% by yearend.  Englund is chief economist for Action Economics
BW MALL
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