An August Vacation for Inflation


By Michael Englund and Rick MacDonald You wouldn't know that crude-oil prices spiked to their highest levels in two decades in August from the Commerce Dept.'s

consumer price index (CPI) report for the month, released Sept. 16. Both the overall CPI number and the core index, which excludes food and energy prices, rose just 0.1%, vs. economists' median forecast for both to gain 0.2%.

The tame U.S. CPI figures for August complete the mix of major inflation measures for the month, and it's now clear that August was a weak-price month despite the historic surge in petroleum costs. The data support our view at Action Economics that this price-acceleration cycle's peak is over.

MUTED OUTLOOK. It's unclear why the big, though temporary, surge in wholesale oil prices that did hit the import price index did not get passed through to the CPI. A likely explanation is that the jump largely reflected speculative positions that had little impact on actual refinery costs, with wholesale prices falling before any meaningful upward retail price pressure appeared.

In any case, the energy aggregate, a measure of prices in that sector, actually declined 0.3% in August, led by a 1.4% drop in gasoline prices. Holding down the core index was a 0.3% decline in new-vehicle prices and a below-trend 0.2% gain in medical-care costs. Weakness was also evident in apparel and transportation prices, which fell 0.2% and 0.3%, respectively, after both dropped 0.8% in July.

The food price free fall that depressed producer prices and the export price index in August had little impact on CPI, where we saw a 0.1% climb in food costs.

LONG-TERM BLIP. On a year-over-year basis, CPI inflation fell from 3% in July to 2.7%, where it will likely stay though yearend. The "core" CPI year-over-year measure fell to 1.7%, from 1.8% in July, and this measure will likely go only slightly higher through yearend.

Little inflation pressure is in the system, and now that the likely peak in energy prices has passed, the impact from this volatile sector will presumably no longer be upward. Most of the year-over-year measures should fall in the first quarter of 2005, when these numbers will face increasingly easy comparisons to 2004.

From a longer-term historical basis, current year-over-year core inflation remains low. While the worst of the inflation news is likely over, the Federal Reserve could conceivably take comfort in the fact that the upswing this year is barely noticeable on longer-term charts.

Ultimately, the August data won't forestall a rate hike by Alan Greenspan & Co. on Sept. 21. Action Economics expects the central bank to hike the Fed funds target rate by a quarter-point, to 1.75%. We expect the rate to reach 2% by yearend. As long as core inflation remains under 2% on a year-over-year basis, the Fed will be comfortable with its "measured" pace of tightening. Englund is chief economist and MacDonald director of investment research and analysis for Action Economics


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