November 16, 2006 (Prices Byte)
By Dean Baker
The overall CPI fell by 0.5 percent in October, driven largely by a 7.0 percent decline in energy prices. The core (excluding food and energy) CPI rose by 0.1 percent, slightly less than had been expected. The annual rate of inflation over the last three months has been -2.9 percent, as energy prices have fallen at a 43.8 percent annual rate over this period. The annual inflation rate in the core over the last three months has been 2.3 percent, down somewhat from the 2.7 percent rate over the last year.
There were a few anomalies that lowered the core inflation rate in October, notably a 0.7 percent drop in apparel prices (this follows large increases in the prior 2 months), a 1.2 percent decline in used car prices, a 0.6 percent drop in video and audio products, and a 0.5 percent decline in hotel prices. On the other side, the 0.7 percent rise in phone prices is not likely to be repeated.
The medical care and education components continue to show substantial inflationary pressure, rising by 0.3 percent and 0.6 percent, respectively. It appears that rental inflation is abating. The owners’ equivalent rent measure, which is not affected by utility prices, has risen at a 3.9 percent annual rate over the last quarter. This compares with inflation rates of 4.5 percent and 5.5 percent in the prior two quarters. The record housing vacancy rates will continue to put downward pressure on inflation in this sector in the months ahead.
The moderation of inflation was also evident at earlier stages of production. The overall finished goods index declined by 1.6 percent in October, driven by sharp declines in both food and energy prices. The core finished goods index also declined, dropping by 0.9 percent, mostly as a result of large declines in the prices of cars and light trucks.
While these price declines were clearly anomalies, the October price reports provide considerable evidence that inflationary pressures at the wholesale level are dissipating. The overall intermediate goods index fell by 1.1 percent, while the core index was flat. The overall crude goods index fell by 10.5 percent and the core index dropped 1.3 percent. Over the last three months, the core intermediate goods index rose at a 4.8 percent annual rate, down from a 5.9 percent increase over the last year. The core crude goods index has declined at an 11.6 percent annual rate over this period, compared to an increase of 20.1 percent rate over the last year.
The anomalies in the October price report make the pattern of inflation going forward difficult to gage. The extraordinary price drop in the overall CPI has clearly ended now that energy prices have stopped their plunge and may be creeping up again. However, even the future of the core index is difficult to assess. Inflation in the rental component, which comprises almost 40 percent of the core index, is likely to slow gradually in the months ahead. There continues to be moderate inflation in other components, which may pick up slightly if productivity growth stays on its recent weak path (1.3 percent over the last year) and nominal wage growth remains near 4.0 percent.
The producer price indices indicate that there is less inflationary pressure at earlier stages of production. This is especially notable with construction materials, which had been experiencing substantial price increases earlier in the year due to the building boom. With both the overall and core intermediate and crude goods indices showing rapid rates of inflation earlier in the year, there was reason to believe that these higher prices would show up in higher inflation at later stages of production. There is far less basis for this concern with the most recent price data.
It is not clear how the Fed is likely to respond to these reports. Core inflation remains close to 2.5 percent, somewhat higher than the Fed’s target rate. However, the economy is clearly weakening as falling house prices are limiting the ability of consumers to borrow.
Dean Baker is Co-director of Center for Economic and Policy Research in Washington, D.C.
Prices Byte is published each month upon release of the Bureau of Labor Statistics’ reports on the consumer price and the producer price indexes.