March CPI Won't Sway Inflation-Wary Fed

The 0.1% rise in "core" consumer prices was smaller than expected, but inflation is still above the central bank's comfort zone. Plus: housing starts, industrial output

by Michael Englund and Rick MacDonald

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Reports released Apr. 17 contained some good news on consumer prices—though probably not enough to change the Federal Reserve's inflation-focused policy bias—along with indications of continued stability in the housing sector. Another report on industrial output suggested that economists might have to take their first-quarter U.S. growth forecasts down a notch.

Here is Action Economics' rundown on the key Apr. 17 releases:

Consumer price index (CPI): The U.S. CPI report revealed the expected hot gain in the headline index, with a 0.6% increase, which was similar to the troublesome 1.0% headline surge in the producer price index (PPI) for the month. Yet the restrained 0.1% increase in the core figure—which excludes volatile food and energy prices—also paralleled the PPI report, where the core figure was flat, to leave a positive spin on the report.

Energy prices remained on the boil in March, climbing 5.9%. Food prices rose 0.3%, a third consecutive monthly increase. Housing costs were up 0.2%, with the owners' equivalent rent component up 0.3%, while fuels and utilities climbed another 1.2%. Medical care costs were up 0.1%. Apparel prices surprised, and fell 1.0%.

On a year-over-year basis, headline consumer prices are running at a strong 2.8% pace, compared to 2.4% previously. The core rate slowed to 2.5%, however, from 2.7%. The drop in core year-over-year inflation will be followed by a further moderation to 2.4% in April if we get a 0.2% gain over March, and the headline year-over-year gain of 2.8% should be followed by a drop-back to the 2% area by May if food and energy prices stabilize, due to easy comparisons.

We now expect a 0.5% headline March personal consumption expenditures (PCE) gain, with a 0.1% core increase, and with gasoline price strength similar to that signaled by the March retail sales report. The PCE chain price index for the first quarter is dancing around 2.4% and the first-quarter gross domestic product (GDP) chain price gain will sit near 3.3%; both will prove troublesome to the Fed given the 1%-2% "comfort zone." Until core inflation posts a meaningful moderation, or until the economy slows more significantly, the Federal Open Market Committee (FOMC) will focus more on inflation pressures than economic risks.

Housing starts: Housing starts rose 0.8% to a 1.518 million-unit annual pace in March, following February's revised 7.6% increase to a 1.506 million-unit rate (from 1.525 million previously). Permits rebounded 0.8% to 1.544 million, marking the first increase in 2007 (permits were also lower in 10 of the 12 months in 2006).

A surge in starts in the Midwest (44.5%) was responsible for all of the gain in total starts, as starts in the three other regions were lower. Housing completions dipped 0.7% in February following a sizable 10.2% drop. Units under construction fell 1.1% to 1.195 million units, consistent with our expectations for further softness in residential construction during March.

The housing-starts figures through March leave a restrained picture of activity for the sector, with a bounce that left the figures above market expectations but short of our estimate. Permits have revealed a remarkably stable 1.53 million-1.57 million range this year, with a general sideways pattern around this range since October. And the concentration of the bounce in the Midwest was consistent with assumed first-quarter weather distortions.

We still expect construction spending to rise by 0.5% in March following the surprising 0.3% February gain, thanks mostly to the robust construction employment data for the month. We continue to expect existing home sales to fall by a hefty 5.1% to a 6.35 million-unit annual rate in March from the bloated 6.69 million reading in February, due to lagged weather effects, while new home sales are expected to bounce 8.5% to a 0.92 million rate from a depressed February reading.

The outlook for housing remains dicey, and new homebuilders have exhibited some renewed pessimism. Yet most housing measures are continuing to suggest a sideways pattern overall as we enter the spring sales season.

Industrial production: March industrial production declined 0.2%, which left capacity utilization at 81.4%, from a downwardly revised 81.6% in February. Industrial production figures for January and February were revised lower.

Weakness was paced by a big unwind in utilities, which posted a 7.0% drop following the 7.6% gain in the prior month, as the unusually cold February weather gave way to an unusually warm March. Manufacturing jumped 0.7%, despite only a 0.2% gain in motor vehicles. Mining increased 0.1%.

The new figures leave a 1.4% growth rate for the industrial production index in the first quarter, following a 1.5% rate of decline in the fourth, with the swing between the quarters exacerbated by toned-down but still partly intact utility effects from the warm November and December but cold January and February.

The industrial production index sharply underperformed the 2.5% GDP growth clip in the fourth quarter, but is now in line with our revised 2.2% GDP estimate for the first quarter.

Englund is principal director and chief economist for Action Economics. MacDonald is director of investment research and analysis for Action Economics.