A Cool June for Inflation?

Despite the month's spike in crude prices, Action Economics says the CPI and PPI shouldn't rise enough to alarm the Fed

By Michael Englund and Rick MacDonald

How will the surge in oil prices during June make itself felt in two key inflation measures for the month: the consumer price index and producer price index?

We at Action Economics expect the overall CPI, set for release July 14, to rise 0.2%, vs. economists' median forecast of a 0.3% increase. The core CPI, which strips out volatile food and energy prices, is expected to rise 0.1% (median 0.2%).


  Our forecast for the PPI, scheduled for July 15, calls for a 0.5% jump in the overall index (median 0.4%), while the core PPI increases 0.1%, in line with the median estimate.

For consumer inflation, oil prices spiked on the month, although retail gasoline prices have lagged behind much of the run-up in the spot market. In fact, we expect retail gasoline prices to fall 1%. We forecast that the core CPI will be held down by vehicle prices, as General Motors' (GM ) "employee discount for everyone" put notable downward pressure on stickers.

Financial markets will home in on the core CPI to gauge whether the strength in the economy and rising labor costs are beginning to pass through to higher consumer-level inflation. The core CPI data continue to exhibit a slow but steady uptrend typical of the middle years of an expansion. Yet year-over-year core inflation remains relatively low from a longer-term historical perspective basis.


  The monthly figure in May left the core rising at a 2.2% year-over-year rate for the second straight month, compared to 2.3% in March and 2.4% in February. Outside of the last two years, this represents one of the lowest growth rates since the 1960s.

On the wholesale front, gasoline will have a much bigger impact. In keeping with the surge in crude-oil prices on the month, we expect wholesale gasoline to jump 10% on a seasonally adjusted basis, in stark contrast to mild reaction on the retail (consumer) side. As with the CPI, the GM "employee discount" blitz implies downside risk for the core index of the PPI as well, as the factory discount program reduces wholesale prices of vehicles to dealers. Outside of oil, this should be a benign report, however.

The overall trend for wholesale prices remains favorable. Recent surveys by the Institute for Supply Management (ISM) suggest price pressures have posted a notable deceleration in recent months, although figures for the June survey were contradictory.


  The ISM price index plummeted to 50.9, from 58, which is the lowest level since February, 2002. The ISM nonmanufacturing price index, however, bounced to 59.8, from 57.5. We would note, though, that the May figure was the lowest since August, 2003.

In the meantime, while the overall PPI has been on a sharp upward trajectory for well over two years now, and core inflation has been accelerating for nearly two years, a case can be made that the worst is behind the economy in regard to increases in the key inflation index. The May figures left the overall year-over-year rate falling to 3.5%, from 4.8%, while the core index held at 2.6% for the third straight month following a 2.8% gain in February.

What are the possible implications for monetary policy from the two reports? The June CPI and PPI data aren't expected to change the outlook for Federal Reserve policy, though further softness in these reports would support the Fed's view that inflation pressures remain contained.

At Action Economics we're sticking with our forecast of a 4% Fed funds target rate by yearend, 75 basis points above the current 3.25%.

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

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