Just When You Forgot All About Inflation...

Judging by the subsequent decline in long-term interest rates, January's 0.5% surge in consumer prices--the largest gain in two years--was a nonevent. The financial markets apparently concluded that the rise was a fluke and that President Clinton's economic plan was more likely to temper inflationary pressures than exacerbate them.

Even if this is true, however, several economists believe that coming inflation reports may be stronger than observers expect. "At least for a while," says Joseph Carson of Dean Witter Reynolds Inc., "any inflationary surprises are likely to be on the up side."

Carson points out that prices of many industrial materials, including lumber, copper, and steel scrap, are on the upswing. The Journal of Commerce's price index of 18 industrial commodities recently hit a two-year high (chart). And the producer price index for crude goods excluding food and energy rose 5.4% between November and January, bringing it 8.9% above its year-earlier level.

None of this means that inflation is about to take off. Indeed, economist Albert T. Sommers of the Conference Board sees the strengthening of commodities prices as "good news." Along with the recent surge in factory orders and sharp drop in inventories, "the pickup in materials prices suggests that America's industrial markets are finally participating in the recovery," he says.

Commodity price strength not only reflects a pickup in orders from purchasing agents, notes Carson, but also gives them an added incentive to rebuild inventories. Companies start boosting stocks both to meet rising demand and to beat future price increases. And as prices firm, they begin to feel more confident about boosting investment.

Looking ahead, Carson sees a "compositional shift" in price pressures away from service-producing industries toward commodities and goods. But neither he nor Sommers believes that a significant acceleration in inflationary pressures is on the horizon--at least for the next year and perhaps longer.

For one thing, with most major industrial economies outside the U.S. mired in recession, further rises in industrial prices are likely to be restrained. For another, overall inflation has almost always declined in the early years of past cyclical upswings, as rising productivity offset higher materials costs, allowing manufacturers to enjoy higher profits while limiting price hikes.

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