Stronger Signals of Growth—and Inflation

Retail sales and business inventories show that the economy remains steadybut an update on trade prices signals inflation risks

U.S. economic reports released on Jan. 12 revealed a robust round of spending and price data for the fourth quarter that, along with moderate inventory figures, have further dampened lingering fears about just how much economic growth slowed in the runup to 2007. But the reports also show ongoing inflation risks.

The reports show that consumption is entering the first quarter on a strong trajectory. Trade prices entered the first quarter on a notably robust path as well, though we may see some price correction in January and February if energy prices remain weak and the dollar bounce remains in place. Inventories are revealing a fourth-quarter correction, but not at the jarring pace that was feared.

Here is Action Economics' rundown of the Jan. 12 reports:

Retail sales

December retail sales jumped 0.9% (vs. economists' median forecast of an 0.7% rise), while the aggregate excluding auto sales increased 1.0% (median 0.5%). The jump in gasoline prices on the month left the gasoline service station component with an increase of 3.8%. Most other components revealed solid gains, with the exception of a 2.6% drop in miscellaneous store retailers and a 1.1% drop in building materials.

The report revealed downward revisions in both October and November that offset the upside surprise for December, to leave a report that was in line with our ongoing assumption of robust growth for sales. We now assume a 4.6% real consumption gain in both the advance fourth-quarter gross domestic product report and in the 2007 first quarter.

Note that, despite the strength in the December retail sales data, we have yet to see the January boost that may well come from gift cards and warm weather, as seen last year when sales soared by 3%. The seasonal factors for auto sales also leave room for a sizable bounce in January. And, gasoline prices are again declining, which will provide more fuel to the consumption fire as the first quarter unfolds.

Trade prices

December import prices jumped 1.1% (median 0.6%), while export prices increased 0.7% (median 0.2%). As for imports, petroleum jumped 4.8%, while the ex-petroleum aggregate increased 0.4%. Looking at exports, prices of agricultural goods jumped 2.2%, while the aggregate excluding ag-goods increased a solid 0.5%.

The indexes revealed sizable upside surprises in both the import and export headline figures for December, with strength in both petroleum import and food export prices, as well as both sets of core figures. The data suggest upside risk to the other inflation reports for December, especially given the robust gasoline sales data in the retail sales report. However, we will keep our other forecasts unchanged.

We assume a 0.4% gain in the December headline consumer price index, with a 0.2% core (excluding food and energy) gain, and personal consumption expenditure chain price gains of 0.3% overall and 0.2% for the core. We continue to expect a quirky seasonal adjustment factor for the producer price index in December to leave a big energy-led headline gain of 0.7%, despite an assumed flat core PPI gain.

Note that the recent strength in the trade price data should be partly reversed in January, as energy prices are again falling, and the dollar is bouncing after a fourth-quarter bout of weakness.

Business inventories

November business inventories increased 0.4% (median 0.3%), while sales rose 0.5%.

Back data were revised lower. The data left the inventory-to-sales ratio unchanged at 1.30. The only new figure in the report was retail inventories, which fell 0.3%.

Overall, business sales were buoyed in November by strength in retail sales and wholesale trade, alongside subdued factory shipments. Inventory growth in November was restrained by the retail sector, though with factory and wholesale gains that exceeded our assumptions.

The November report revealed weaker retail inventory figures than we had assumed given recent reported strength in factory and wholesale inventories in November, but the data are still in line with our 2.7% fourth-quarter and 2007 first-quarter real GDP estimates. Vehicle inventories have declined for four months through November, leaving levels now roughly in line with current sales.

The November numbers imply a GDP inventory subtraction of a hefty $27 billion in the fourth quarter, alongside a likely robust 3.8% growth rate for real final sales. We expect the inventory correction to continue into the first quarter, with inventory growth approaching zero before recovering later in the year.

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