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Inflation's Fuel-Powered Ride

By Michael Englund The producer price index (PPI) rose 0.7% in October, while the core -- which excludes food and energy prices -- fell 0.3%, following September gains of 1.9% and 0.3%, respectively. On a year-over-year basis, overall producer prices slipped to a 5.9% growth rate, from 6.9% previously, while the core year-over-year rate dove to 1.9%, from 2.6%.

Among the components, gasoline prices fell 3.3% on the month, after a 12.7% surge in September, though other energy prices were strong. Intermediate-goods prices were up 3%, from 2.5% previously, and are up 10.5% year-over-year. Crude-goods prices rose 6.7%, after a 10.2% gain in September.

UPSIDE SURPRISES? The PPI figures reflected broad-based energy price strength, given the 4.1% finished energy price surge, despite the 3.3% gasoline price drop. This leaves a more dramatic, energy-led roller-coaster ride for the inflation numbers likely as we enter 2006. We now assume a flat overall consumer price index (CPI) figure for November, with a 0.2% core gain in that measure.

The PPI index is probably now poised for 0.5% to 1% declines in both November and December. As long as the available figures on record stay strong, though, the markets will remain braced for upside surprises in other inflation reports. Note that the drop in year-over-year headline inflation, from a 6.9% September peak to 5.9% in October, should be followed by a 4% to 5% rate in November and gains in the 4% area by yearend, as this energy price pop unwinds.

Though CPI year-over-year inflation reached 4.7% in September, we expect this measure to drop back to 4.1% in October and fall into the 3.5% area as we enter the new year.

ONE-OFF OR PERMANENT? The Federal Reserve will see the effects of Hurricane Katrina on energy prices as a one-off effect for the U.S. inflation data. But it remains worrisome that U.S. inflation numbers through this cycle have been plagued by a series of "one-off" price gains that proved permanent.

The strength we expect in fourth-quarter inflation from Katrina -- to be followed by seasonal strength in the first quarter, even as this energy price spike unwinds -- will place ongoing pressure on the Fed to be diligent.

Englund is chief economist for Action Economics

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