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A Gathering Inflation Cloud

Economic Trends


Strength in services adds pressure

If you want to know what's happening in the U.S. economy, watch the mammoth services sector. So says economist William V. Sullivan Jr. of Morgan Stanley Dean Witter, who warns that Wall Street's preoccupation with retail sales and goods prices could lead many to misgauge the strength of business activity and inflationary pressures.

To be sure, the inflation yardsticks have rarely looked so promising. The producer price index declined 0.2% in November and was down 0.6% over the past 12 months. Import prices, which are not counted in the PPI, are running over 3% below their year-earlier level. Industrial commodity prices are hitting 40-month lows. And the consumer price index at last count was rising at an exceedingly modest 2.1% annual rate.

Although turmoil in Asia has helped on the price front, several domestic developments also appear favorable. As a result of revisions in capacity growth, for example, the Federal Reserve has just slashed its reading of capacity utilization in manufacturing from 83.3% to 81.7%--below the 83% threshold associated with past inflationary flare-ups. And the Commerce Dept. reports that retail sales fell in September and October, implying a slowdown in consumption.

The problem, claims Sullivan, is that focusing on such trends in the goods sector neglects the growing importance of services in the economy. Take consumption expenditures: From 1993 to 1996, outlays on services jumped from 56.1% to 58.3% of household spending, and at last count they were running at 59.1% (chart). "This rapid shift," says Sullivan, "means that retail sales are becoming a less reliable guide to the economy's momentum."

The 3% gap between the 1992 share and the latest reading, he notes, represents some $166 billion in added annual outlays allocated to services. Thus, just looking at the recent decline in retail sales misses the fact that growing services spending has kept overall consumption strong--rising at a 4.8% annual clip in September and October even as retail sales fell at a 2.4% rate.

The impact of service-related outlays on inflation is also growing, claims Sullivan. Service establishments don't have to worry about foreign competition, so they're much freer to respond to buoyant demand conditions and labor shortages by raising wages and lifting prices.

The warning signs are already apparent. Hourly wages of service-sector employees in November were up 4.5% over their year-earlier level, vs. 3.4% for factory workers. And the services component of the consumer price index is still rising at a 3% annual clip, compared with 1% for the goods component.BY GENE KORETZReturn to top

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Where retail space is at a premium

The lineup of expensive shopping streets shifted a bit in 1997, as did the range of rents among the top six: $243 to $771 per square foot, vs. $261 to $754 in 1996. According to Healey & Baker, a London affiliate of Cushman & Wakefield Inc., Hong Kong's Causeway Bay is still top dog, but New York's East 57th Street has replaced Fifth Avenue as the world's second-priciest venue. In addition, London's Oxford Street and Sydney's Pitt Street moved into the top six, elbowing out chic thoroughfares in Zurich and Vienna.

Looking ahead, Healey & Baker believes Europe is likely to post the largest increases in retail rents in 1998, with major shopping streets in Spain, Britain, and Germany leading the way.BY GENE KORETZReturn to top

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