Energy Fuels an Inflation Surprise


By Michael Englund and Rick MacDonald So that's where the impact from the oil-price spike was hiding: The overall

Producer Price Index (PPI) -- a measure of inflation at the wholesale level -- surged 1.7% in October, according to a Nov. 16 report from the Commerce Dept. The monthly gain was the largest since January, 1990, and well above the economists' median forecast of a 0.5% gain.

Meanwhile, the core index, which excludes food and energy prices, jumped 0.3%, vs. the 0.1% median forecast of economists surveyed by Action Economics (see BW Online, 11/16/04, "The Higher Price of Economic Growth").

NOT ALL UP. The October surge in the overall index explains the mystery of the lack of "follow-through" impact from wholesale energy prices to government inflation indexes. And the size of this number suggests additional upside risk for the month's

Consumer Price Index (CPI) report, scheduled for release Nov. 17.

The gain in the core index actually moderated to a 1.8% year-over-year rate, vs. 1.9% in September. But the aggregate September year-over-year inflation rate soared to 4.4%, from 2.2%, the highest since a 4.9% monthly peak last May. For overall inflation, 2004 is turning out to be an energy-led doozy, despite what appears to be a lack of significant inflation pressure in the "core" measures.

It wasn't just oil prices. Gasoline prices jumped 17.3%. Finished energy goods prices rose 6.8% in October, following a remarkable 0.9% drop in September. The PPI, excluding food and energy, often mirrors months with huge swings in energy prices, and it's not surprising that this measure rose 0.3% in two back-to-back gains in September and October.

The inflation news isn't completely up, up, up. All the major inflation measures are still sharply underperforming the ascendant path we would expect, with a $55 peak in oil prices.

COSTLIER FOOD. Still, we'll now see a hardy 6% PPI inflation rate for the fourth quarter, following the surprisingly flat 0.6% rate in the third, even if PPI falls 0.3% through the last two months of the year. That yearend slide might be expected, given the decline already seen in prices for West Texas Intermediate crude oil. These numbers are similar to the 6.1% growth rate in the second quarter and above the 3.9% rate of the first quarter, though still not as strong as soaring oil prices through the summer months would normally have indicated.

Though the oil-price surge captured the headlines, it's noteworthy that food prices also surged 1.6% in October. Generally, food prices were strong in the first half of the year and weak in the second half. We're now seeing some inflationary bounceback that may well reflect distortions from the Florida hurricanes, given the big surge in vegetable and fruit prices.

Among other segments of the report, the introduction of new vehicle prices by manufacturers for the 2005 model year left a 1.3% price decline for cars but a 2.7% increase for trucks. Capital-equipment prices rose 0.4% (boosted in part by trucks), while tobacco prices rose 1.2%.

MORE RATE HIKES. The November report should offset somewhat the strength in the October numbers, as oil has already come well off the highs. Truck prices and capital equipment may moderate as well, following the strength in October.

How will the Fed react to this October surprise? The jump in prices will certainly draw the attention of Alan Greenspan & Co. and should keep the central bank on track for another quarter-percentage-point tightening at the December FOMC meeting. Englund is chief economist and MacDonald global director of investment research and analysis for Action Economics


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