Vital Signs: Will Inflation Keep Easing?

On tap: April consumer price, industrial production, and housing construction data, plus May regional factory activity and consumer sentiment

by James Mehring

The Federal Reserve remains focused on inflation. In the statement after the May 9 monetary policy meeting, the central bank reinforced its view that inflation is the "predominant policy concern." Even though prices outside of food and energy are expected to grow at a slower pace, they are currently "elevated" in the Fed's view. What's more, economic growth is expected to pick up through the year.

The Fed's underlying expectations of easing inflation and improving growth will face another test this week. The financial markets will be most interested in the April consumer price index data. Energy prices are once again expected to make the headline reading look high.

But it's the core inflation figures that are more important. Excluding food and energy, prices rose 2.5% from a year ago in March, from 2.7% in February. A similar easing would likely make the stock market happy, as it would seemingly reduce the need to raise rates. It would also likely lead those economists who are forecasting interest rate cuts later this year to reaffirm that expectation.

Two key core CPI components to look at are rents and owners' equivalent rent. They make up nearly 40% of the core index and have been running at yearly clips of 4.6% and 4.1% respectively. The housing recession has lifted demand for apartments and, therefore, rents. Since rents are also used by the Bureau of Labor Statistics to calculate homeowners' cost of shelter, there has been the odd effect of lifting owners' equivalent rent. With more homes and condominiums being converted into rental units, some downward pressure on core inflation could come soon.

When it comes to economic growth, the Federal Reserve's April industrial production data is the report to read this week. The big number in this report is manufacturing output. A good result could shift some recent views among investors and economists. First, manufacturers and other businesses now feel better about inventory levels relative to demand. Second, business investment is set to improve. That latter point would be bolstered if business equipment output also posts another impressive gain.

Housing has been the primary drag on economic activity. The April housing starts data will shed some light on whether conditions are finally stabilizing. A positive result would offer some hope that the double-digit drops in residential investment in each of the past four quarters is about to stop.

Besides the data, there is a bevy of Fed speeches. It is unlikely that anything surprising will be in the actual prepared remarks -- the markets will pay close attention to answers to questions.

Here's the weekly economic roundup, from Action Economics.