Vital Signs: Focus on Industrial Production, Housing, Deflation

On deck: homebuilders' survey, housing starts, industrial production, import prices, and producer and consumer price indexes

By James Cooper

As Washington scrambles to get its rescue acts together--for both the economy and the financial markets--the economic reports this week will continue to show just how desperately both are needed. Economists believe the economy this quarter is still contracting about as rapidly as it did in the fourth quarter.

Consumers offered a ray of light, given the better-than-expected 1% jump in January retail sales, but that's clearly not indicative of a turnaround in consumer spending. Despite the rise, buying at the start of the first quarter was still far below the fourth quarter level. Spending will still most likely post a third consecutive quarterly decline, something that has never happened since reporting began in 1947, and the labor markets continue to weaken.

The main story for economic growth in the first quarter will be the huge inventory liquidation that is expected to put major downward pressure on growth in real gross domestic product. The rise in January retail sales may have helped to pare down some of the excess stockpiles built up last quarter, but the sudden drop-off in demand had pushed inventories far out of line with sales. In December, the ratio of business inventories to sales, with both components adjusted for inflation, stood at 1.38, up sharply from 1.32 only six months earlier and near levels not seen in six years.

The plunge in orders and production and the ongoing loss of jobs are direct offshoots of efforts by businesses to correct this inventory imbalance. This week's report on industrial production in January, due on Wednesday, will reflect those cutbacks, especially by carmakers, whose dealers' lots are overflowing. In the final six months of 2008, manufacturing output fell at an annual rate of 16.7%, the fastest such contraction since the 1973-75 recession.

The rest of this week's reports will cover three main areas. The first is housing, starting on Tuesday with the February homebuilders survey. Then on Wednesday the government offers a look at January housing starts. Both are at record lows and still reeling from the economy's accelerating weakness.

The second group of reports will cover inflation. Look for January reports on import prices on Wednesday, producer prices on Thursday, and consumer prices on Friday. The markets are most interested in signs of outright deflation, especially in the core indexes, which exclude energy and food. Consumers' response to post-holiday discounting and recent efforts by high-end retailers to cut prices may be the early signs that a deflationary psychology is creeping into consumer and business behavior.

Then finally, several Federal Reserve officials will be speaking, including Fed Chairman Ben Bernanke on Wednesday. The markets will be listening closely to what he has to say about the Fed's ongoing efforts to stabilize the credit markets.

The U.S. markets will be closed on Monday in observance of Presidents Day. Here's the weekly economic calendar, from Action Economics: