Core-CPI lower than expected, but food & energy rise (May 14, 2008)

Markets are breathing a sigh of relief today based on the CPI numbers released by the Bureau of Labor Statistics. When you look into the report, despite lower than anticipated core CPI numbers, there are reasons to worry

The seasonally adjusted CPI increased by 0.2 percent in April while the core CPI, the CPI excluding food and energy, increased by 0.1 percent, below market expectations. Financial market investors expect he lower than expected number will give the Federal Reserve cover to keep interest rates low. Of course Fed policy is forward-looking so the numbers from last month are only helpful if they are indicative of future movements. Fed officials have expressed concerns about inflation in the last week and the Bank of England announced concerns over inflation recently too.

Reliance on the core CPI alone as an indicator of economic policy would be misguided. Low, stable rates of inflation is sound economic and social policy. Inflation is a bigger factor for those who are forced keep their assets in cash or near-cash substitutes, which is typically those with lower incomes. The real purchasing power of their income erodes in the face of high levels of inflation. Low interest rates may be necessary to generate economic recovery eventually, though such a policy alone is not sufficient and certainly does little to help those in lower income brackets.

In the last twelve months the price of gasonline is up 20.9 percent, the price for natural gas increased 10.9 percent and the price of electricity rose 5.0 percent. The price of bread is up 14.1 percent from a year earlier while milk prices over the same time increased 13.5 percent. The overall index for food at home increased 1.5 percent in April while food away from home increased 0.3 percent. Consumers really cannot substitute away from gasoline and food and therefore reduce expenditures in other areas. As a result demand for goods outside food and energy fall and prices pressures are more contained, leading to a lower core CPI number as we saw in April.

There would seem to be little reason to rejoice at these CPI numbers as they reflect the continued pressures on American consumers over the last several months and do not point to turnaround in the economic situation in the near future. While these data may allow the Fed to keep interest rates lower for longer it is not clear that inflation is contained and that such policy will create an improving situation in the short run or long run.