Inflation's Renewed Muscle
By Michael Englund and Rick MacDonald
The array of U.S. economic reports for October released Nov. 17 sent a shot across the bow of the Federal Reserve. Stronger-than-expected numbers on consumer-level inflation, the housing sector, and manufacturing will leave Alan Greenspan & Co. with much to chew on at upcoming policy meetings.
The first key release, the October consumer price index (CPI), provided yet another upside surprise on inflation. The overall index jumped 0.6% on the month, vs. economists' median expectation of a 0.4% rise. And the core index, which excludes volatile food and energy prices, rose 0.3% (vs. median expectations of a 0.1% gain) following the outsized 0.3% gain in September.
Similar to the producer-price report released Nov. 16 (See BW Online, 11/16/04, "Energy Fuels an Inflation Surprise"), the big story on the month was the pop in energy prices. The energy aggregate rose 4.2%, led by an 8.6% surge in gasoline. Food prices also rose 0.5%. The October CPI gain left a bounce in year-over-year inflation to 3.2%, which leaves the rate just below the prior oil-led cyclical peak of 3.3% in June.
The CPI data, together with the October producer-price numbers, reveal a solid upward trend in both overall and core inflation through October, despite perceptions that price gains are under control. Even if oil prices hold their recent pullback, the year-over-year CPI gains are likely to rise to around 3.5% over the coming two months. The core CPI year-over-year rate of 2.0% will hold over the coming two months even if the monthly core figures are flat, and are likely to continue to trend upward from the short-lived 1.1% low point in core inflation set last December.
Meanwhile, housing data revealed continued strength. October housing starts jumped 6.4% to a 2.027 million unit annualized pace (the median forecast was 1.96 million), while permits issued moderated 0.7%, to 1.984 million units. The jump in housing starts supports the view that hurricanes and related weather conditions did depress activity in September, with October marking a rebound from that level.
Most market economists entered 2004 expecting a drop in housing activity for the year, given the enormous "overshoot" of activity through the recession -- and this expectation has again been put off another year. But the momentum in the economy and job market, combined with mortgage rates that remain near generational lows, continues to provide a solid backdrop for housing. Indeed, any slowdown in the sector remains conjectural, as most major housing statistics are hovering near cyclical highs. Overall, 2004 should be another record year for housing, with starts posting a 3% to 4% gain on top of the strong 2% to 8% gains in each of the prior three years.
A third report showed renewed signs of life in another key sector: manufacturing. The government's measure of industrial production jumped 0.7% in October (the median forecast was 0.4%), which left capacity utilization at 77.7% (median 77.4%) from a revised 77.3%. Manufacturing jumped 0.7%, led by a 2.3% gain in vehicles and parts, while utilities and mining also posted 0.7% gains. The rebound largely confirmed that weakness in August and September was hurricane-related and is now being unwound.
Overall, factory surveys continue to suggest solid growth. We at Action Economics think industrial production is poised for 6% growth in the fourth quarter following the hurricane-led slowdown in the third quarter to a 3.2% rate of increase. Ongoing strong demand, depleted inventory levels, and the more attractive value of the dollar relative to recent years all bode well for industrial production over the near term. While the current reading of capacity utilization suggests that slack remains in place, manufacturing is experiencing a healthy recovery as firms meet steady growth for equipment spending alongside efforts to restock shelves.
Where does this latest round of data leave the Fed? While the upside in October inflation figures should keep the central bank in tightening mode, the sharp reversal in oil prices over the last few weeks suggests at least some of the October pop will be reversed in November.
Still, any further surprise jumps in inflation over the coming quarters -- coupled with the potential for accelerating strength in housing and manufacturing -- could quickly make the Fed appear to be "behind the curve" in its tightening trajectory. For now, though the uptrend in U.S. inflation as gauged by official inflation statistics is clear, it appears the Fed has some time to tighten policy and can credibly stick to its policy of tightening at a "measured" pace.
Englund is chief economist, and MacDonald global director of investment research and analysis, for Action Economics