JPC: The CPI's Future - February 2008

Volume 25 No. 5

February 2008

Inflation, Interest Rates and the U.S. Dollar Exchange Rate

Accompanying its month-end 50 basis point rate cut, the FOMC statement expressed the expectation that inflation will moderate in the coming quarters. If that statement is taken literally, the forecast is a good bet -- total inflation ran an annual rate of 5.6 percent in October-December, and at the same time, core inflation rose at an annual rate of 2.7 percent. That was up almost a half percentage point from last winter, and clearly above the FRB's comfort zone for core inflation.

Two developments stand out in the fourth quarter inflation picture -- price advances for oil, when crude temporarily hit $100 per barrel, and for other imported goods. Prices of core goods rose at a 0.6 percent rate in the last six-months of the year compared with a 1.1 percent decline during the similar period last year. The import price index for core consumer goods is also accelerating--up 1.6 percent from December 2006, driven upward for some time now by a falling U.S. dollar. That the acceleration in those indexes are close to one another implies that retailers have more than just passed through those import price hikes. They likely also raised their selling prices enough to cover other cost increases, particularly those for energy incurred by the stores directly and, indirectly, in the transportation costs to get them to consumer markets.

Annualized Percentage Changes

6 months ended:

3 months ended:

12 months ended:

June 2006

Dec.

2006

June

2007

Dec.

2007

Sept. 2007

Dec. 2007

Dec. 2006

Dec.

2007

Employment Costs-

Private Industry

Compensation

3.0%

3.4%

2.9%

3.1%

3.1%

3.1%

3.2%

3.0%

Wages & Salaries

3.0%

3.2%

3.7%

3.1%

3.1%

3.1%

3.2%

3.3%

Consumer Prices

   All Items

4.7%

0.4%

5.0%

3.3%

1.0%

5.6%

2.5%

4.1%

    CPI Core

3.0%

2.1%

2.3%

2.6%

2.5%

2.7%

2.6%

2.4%

       Core Goods

1.0%

-1.1%

-0.4%

0.6%

0.3%

0.8%

-0.1%

0.1%

       Core Services

3.9%

3.5%

3.3%

3.4%

3.3%

3.5%

3.7%

3.3%

Producer Prices

   Finished Goods Core

2.7%

1.3%

2.1%

2.0%

1.7%

2.2%

2.0%

2.0%

   Finished Consumer Core

2.6%

1.1%

2.5%

2.5%

2.1%

2.8%

1.8%

2.5%

Capital Equipment

2.8%

1.8%

1.5%

1.2%

1.1%

1.3%

2.3%

1.3%

   Intermediate Core

8.1%

1.0%

4.3%

2.3%

0.0%

4.6%

4.5%

3.3%

   Crude Core

43.1%

-4.2%

26.5%

7.9%

12.4%

3.6%

17.0%

16.8%

Import Prices

Consumer Goods

0.4%

2.0%

0.8%

2.4%

2.6%

2.3%

1.2%

1.6%

   Capital Goods

0.4%

0.7%

-0.4%

2.0%

2.7%

1.3%

0.5%

0.8%

PCE Price Indexes

    Total

3.9%

0.7%

3.9%

3.1%

1.5%

4.6%

2.3%

3.5%

       Core

2.6%

1.9%

1.9%

2.5%

2.4%

2.7%

2.3%

2.2%

     Mkt-Based Core

2.3%

1.6%

1.9%

2.2%

1.7%

2.6%

2.0%

2.0%

This introduces the second primary source of recent consumer price inflation --energy prices. Their impact is ubiquitous. Consumer transportation services prices have picked up sharply. Airline fares helped propel a sharp acceleration -- to an 18.3 percent annual rate -- in consumer costs for public transportation. Also rents, which embed some energy costs, rose strongly in the 4th quarter; some of that rise was probably contributed by a move to rent housing rather than buy it because of mortgage-related problems. While the foregoing examples highlight various energy price impacts on inflation, they also serve to show that much of the fourth quarter's oil price increase has already been reflected in the CPI. And with wage increases seemingly on a plateau at a tad over 3 percent annually, and unlikely to go higher as labor markets weaken, the primary forces likely to determine inflation in 2008 are prices of energy and of the US dollar in foreign exchange markets.

The U.S. dollar exchange rate is probably the easier of the two to forecast -- low U.S. interest rates and the U.S. trade deficit preclude any imminent reversal of the dollar's weakness. The weak dollar will keep prices of oil and other raw commodities up, even as demand slackens. Higher metals prices are among the factors auto companies cite in preparing consumers for noticeably higher prices on 2009 autos. And a weak dollar also means any meaningful drop in oil prices is probably not in the cards.

The FRB is keenly aware of these inflation concerns. It will be prompted to reverse monetary policy just as soon as it discerns that the economy is about to pick up. Meanwhile, some further loosening of monetary policy cannot be ruled out. And even in the unlikely event that clear signs of an upturn are visible as early as this spring, FRB tightening will not forestall a core inflation rate for 2008 that is not much different from last year's 2.4 percent already above the Fed's target.

FORECAST OF THE CPI-U

 
                                                        CPI-U
                        CPI-U           CPI-U       Food & Energy  
                      Index NSAR      Index SAAR      Index SAAR

ACTUAL
2007 - December      210.036  4.1    211.160  3.3    213.148  2.6

FORECAST
2008 Mar.            212.604  3.5    212.391  4.0    214.266  2.4
2008 Jun.            214.221  2.8    213.637  2.4    215.398  2.1
2008 Sept.           214.967  3.1    214.763  2.2    216.625  2.2
2008 Dec.            215.219  2.5    216.370  2.6    218.149  2.6
2009 Mar.            217.512  2.3    217.947  3.0    219.762  2.9

CPI-U: Consumer Price Index, All Urban Consumers, 1982-1984 = 100.
NSAR: Nonseasonally adjusted 12-month percent change.
SAAR: Seasonally adjusted 6-month percent change at an annual rate.

THE CPI'S FUTURE is a publication of JOEL POPKIN AND COMPANY, 1155 15th Street, NW, Suite 614, WASHINGTON, DC 20005, an economic consulting firm specializing in the measurement, analysis and forecasting of wages and prices. The CPI forecasts contained herin are part of its ongoing economic analysis of the U.S. and foreign economies.