Inflation Fears: On, Off, On...

Inflation watchers over the past year have been waiting nervously for the other shoe to drop. While industrial commodity prices, a key leading indicator of both economic growth and inflation, had been climbing sharply since late 1993, both the U.S. consumer price index and the producer price index have remained remarkably restrained.

With both the job market and capacity utilization relatively tight at the close of 1994, it seemed only a matter of time before price pressures filtered down to consumers. Instead, the latest development on the inflation front has actually been a drop in pressure at the other end of the pipeline--in industrial materials prices. The Commodity Research Bureau's widely watched spot price index of 13 industrial raw materials, for example, has just posted its biggest decline since mid-1993 (chart).

Some economists have hailed the drop as confirmation that the U.S. economy is downshifting. "High interest rates and a slowing in demand for big-ticket items is cutting into inventory accumulation," says Joseph Carson of Dean Witter Reynolds Inc. He notes that several auto companies and lumber producers have announced cutbacks in planned production. "With today's tight inventory management," he says, "any slowdown in demand growth can feed back quickly to input prices."

Edward E. Yardeni of Deutsche Bank Securities Corp. thinks the dip in materials prices suggests that the global economy itself may be decelerating a bit. The Mexican crisis has already dampened growth in Latin America, he says, and it is also slowing financial flows to emerging nations in Asia. Since these nations have large appetites for U.S. and European exports (as well as for raw materials), there may be feedback effects on the industrial economies.

Commodity prices are notoriously volatile, of course, so their recent softness may prove shortlived. But for now, their behavior is bolstering the odds favoring a deceleration in U.S. and other economies--and a concurrent relaxation of inflationary pressures.

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