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Next Up: Katrina's Toll on Prices

By Michael Englund and Rick MacDonald Even with big gains in energy prices in August, wholesale inflation appeared relatively restrained for the month. A government report released Sept. 13 showed the overall

producer price index (PPI) rising 0.6% on the month, below economists' median forecast of a 0.7% rise, after a 1% jump in July.

The core rate, which excludes volatile food and energy prices, also came in below expectations, posting a flat reading, vs. the median forecast of a 0.1% increase, after rising 0.4% in July.

FUEL ON THE FIRE. Of course, the August data don't reflect the full effects of Hurricane Katrina, which struck the Gulf Coast on Aug. 29, and we at Action Economics expect that hefty price gains are in the works for September.

On a year-over-year basis, overall PPI surged to 5.1% in August, vs. 4.6% in July and 3.6% in June. But the core rate slowed to 2.4%, from 2.8% in July and 2.2% in June. Energy again paced the gains, as it was up 3.7% on the month, led by a 9.5% jump in gasoline.

That left the energy component up 19.2% year-over-year, after a 4.4% jump in July. But in August, this strength was again somewhat offset by food prices declining 0.3%.

SPRING IN SEPTEMBER. The core index reversed some of the unexpected strength in July, with car prices declining 1.3% in August, following the unexpected 1.5% gain in July. Note that truck prices, however, rose 0.5% in August on top of July's 1.4% gain. The August core reading allowed year-over-year inflation for this measure to fall to 2.4%, from 2.8% in July, though firm core price inflation through yearend is likely given the impact of Hurricane Katrina. We expect the year-over-year core rate to remain largely intact through December.

And what of the outlook for September -- the first monthly report after Katrina? The hurricane has brought significant upside risk for the September data, where the headline number is expected to show a gain of 1.2%, with risk of a disruption-related gain of 0.3% in the core.

Such a move in the overall index would push the year-over-year measure to the 6.1% area in September. Indeed, September should mark the largest year-over-year PPI gain since the 7% figure in November, 1990, following Iraq's invasion of Kuwait earlier that year.

A WARY FED. Our forecasts for another key inflation barometer, the

consumer price index (CPI) for August (scheduled for release Sept. 15) will remain at 0.5% overall and 0.2% for the core rate. We expect hefty gains in September, as well, of 0.8% overall and 0.3% for the core. On a year-over-year basis, CPI inflation should rise from 3.6% in August to the 4.3% area in September, as Katrina takes its toll on that report as well.

The August PPI report isn't likely to have any impact on the near-term outlook for Federal Reserve policy. But September may tell a different story. Though the Fed will see the effects of Katrina as a "one-off" for U.S. inflation data, it will be worrisome for policymakers that the data through this cycle have been plagued by a series of "one-off" price gains that proved permanent.

The strength we expect in fourth-quarter prices from Katrina, to be followed by seasonal strength in the first quarter, will place additional pressure on an already inflation-wary Fed.

Englund is chief economist, and MacDonald global director of investment research and analysis, for Action Economics

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