Inflation Ends '04 Meekly

Thanks mainly to lower energy prices, December CPI figures were modest. Still, expect the Fed to keep up its measured rate increases

By Michael Englund and Rick MacDonald

It looks like some of the recent tailwind behind inflation may have subsided in December. The headline consumer price index (CPI) for the monthly report, released Jan. 19, fell 0.1% from November's level, vs. economists' median forecast of an unchanged reading. Meanwhile, the core index, which strips out volatile food and energy prices, rose 0.2% on the month, in line with the median forecast. This is the third month in a row with a 0.2% "core" price gain.

Overall, the report showed a modest round of inflation figures that reflected the November-December drop in energy prices. Weakness was led by a 1.8% decrease in energy, vs. a 0.2% November gain that bucked the declines seen in that month for wholesale energy prices. The observed market-price slide for oil in November failed to affect many of the month's economic reports, leaving room for payback in December. Especially noteworthy: a 3.7% drop in gasoline prices for December. Most of the core components revealed gains in line with recent trends.


  The modest downtick in overall year-over-year CPI growth to 3.3%, from 3.5% in November, provided some inflation relief for the markets. While the data reverse some of the recent upside in inflation, the gain in the core rate for the month left that index rising at 2.2% on a year-over-year basis. This matches the highest rate since August, 2002.

With a steady uptrend in the core figures through 2004, there's some risk that this trend will continue in 2005. Without trickle-down help from falling energy prices to the core figures in the first half of the year -- a very real possibility in light of the recent oil-price surges -- further core inflation upticks may draw increasing market focus.

We at Action Economics generally remain optimistic that the nation's inflation uptrend through this cycle will be gradual, with oil prices dropping -- after the current bout of cold weather -- providing some reprieve in the overall year-over-year CPI figures. This may have a temporary lowering impact on core inflation rates as well. But the cyclical tendency will be for modest gains in core inflation in both 2005 and 2006, and rates are already approaching the high end of what many Federal Reserve policymakers view as desirable.


  From a longer-term historical basis, current year-over-year core inflation still remains relatively low. While the best news is behind us, the Fed could conceivably take cover in data showing the upswing this year is barely noticeable on longer-term charts. The 2.2% year-over-year core inflation rate for December, outside of the last two years, represents one of the lowest growth rates since the 1960s.

However, this continued push higher suggests that the Fed will, at the least, continue a "measured" pace of interest rate hikes to try to contain further inflationary pressure in the pipeline. As such, the December data still support the ongoing removal of Fed policy accommodation well into 2005. And the central bank may pick up the pace, if inflation expectations begin to push higher as well.

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

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