August 16, 2005 (Prices Byte)
Soaring Energy Prices Propel Inflation in July
August 16, 2005
By Dean Baker
A 3.8 percent jump in energy prices led to a 0.5 percent rise in the consumer price index in July. The core CPI (excluding food and energy) rose by 0.1 percent for the third consecutive month, bringing the annual inflation rate in the core over this period to 1.6 percent. The annual rate of inflation in the overall CPI for the last three months was 1.9 percent.
There were several anomalous factors that helped to hold down the core inflation rate in July. A 0.9 percent drop in apparel prices is at the top of this list. The 0.9 percent drop in July followed a drop in apparel prices of 0.7 percent in June. Apparel prices are always erratic and these declines will almost certainly be reversed in the next few months.
A 1.0 percent drop in new car prices also helped hold down core inflation. New car prices account for 6.1 percent of the weight of the core CPI, which means that this drop in car prices, by itself, lowered the core inflation rate in July by 0.06 percentage points. The price decline for new cars reflects the employee discount incentives being given by the major U.S. automakers. This decline will be largely reversed when the promotion ends in September.
On the other side, there was also a 1.1 percent jump in tobacco prices, which is not likely to be repeated in future months. Also, used car prices increased by 0.8 percent for the second straight month. This will be reversed as car dealers flooded with trade-ins will be forced to cut prices to reduce inventories. Also, there was a 1.2 percent jump in hotel prices, which partially reversed unusually sharp declines in the spring.
Medical care prices rose by 0.4 percent in July. This brings the annual rate of inflation in the sector over the last quarter to 3.9 percent. Data from the prior three months had indicated that inflation in the sector might be moderating.
Education costs rose by 0.6 percent in July, bringing the annual inflation rate in the sector to 7.1 percent over the last three months. This is slightly higher than the 6.5 percent inflation rate in this sector over the last year.
Rental costs continue to trail the overall rate of inflation. The rent proper index rose by 0.3 percent in July, while the owners' equivalent rent index rose by 0.2 percent. Over the last quarter, the annual rate of inflation in these two indexes has been 3.2 and 2.6 percent, respectively. The owners' equivalent rent index (which asks homeowners the price for which their house would rent) is probably giving the better measure of rental inflation at this point. In principle, the rent proper index should not include the cost of utilities, which are often covered in tenants' monthly rent. It is difficult to fully strip out utility costs from this data, so the rent proper index tends to be pulled in the direction of utility prices when they diverge sharply from other prices.
The producer price index for July will not be released until tomorrow (reversing the normal pattern), but the import and export price indices suggest that there is relatively little inflation at earlier stages of production. (Non-agricultural export prices rose by 0.2 percent in July, while non-oil imports fell by 0.2 percent.)
There are powerful forces holding the inflation rate down going forward, most importantly the weakness in the rental housing market, which accounts for 40 percent of the core inflation index. However, there is some reason to believe that core inflation may edge upward, as the Fed seems to fear. The drop in car prices will be reversed in the fall. In addition, the labor market may now be tight enough so that workers' wages can at least keep pace with inflation, after falling behind the last two years. Furthermore, productivity growth has clearly slowed from its extraordinary pace earlier in the recovery. For these reasons, it is likely that the core inflation rate will be in the 2.5 to 3.0 percent range in the fall.
Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.
CEPR’s Prices Byte is published each month upon release of the Bureau of Labor Statistics' reports on the consumer price and producer price indexes.