Consumer price index 'inflation report' shows deflation. No Fed rate hike until 2012?

The consumer price index normally tracking inflation now shows deflation. To some forecasters, this signals recession, meaning that central banks will be keeping interest rates low.

By , Staff writer

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    The price for one gallon of regular unleaded gasoline appears on the sign in front of the Speedway gas station in Aurora, Ohio on May 25. The drop in crude oil prices continues to work its way into retail gasoline prices, one key reason for the decline in the consumer price index (CPI) measuring inflation.
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The overall level of US consumer prices fell in May for the second month in a row, a sign that the economic recovery remains weak.

Normally people call this monthly bulletin the "inflation report." Now the consumer price index (CPI) shows deflation at least since January.

To some forecasters, this signals the risk of dip back into recession in the US. Or, more likely, it means that central banks will be keeping interest rates low for many months to come – perhaps even into 2012.

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The problem: Unemployment is still high, hindering the growth of consumer incomes that would normally drive a post-recession recovery. A slack job market could depress wages, even as high consumer debt levels keep a lid on home prices and consumer spending. Such deflationary pressures could dampen confidence for consumers and businesses.

A crisis surrounding European debt, meanwhile, has caused economists to scale back their forecasts for global growth. In turn, that pushed oil prices down in May.

"Disinflationary and deflationary pressures among the major industrialized countries are gaining momentum," says Brian Bethune, an economist at IHS Global Insight, in a report Thursday. "The Fed has a checkered flag to maintain an extremely accommodative stance on monetary policy."

He cites three indicators of the gap between labor supply and demand: the 9.7 percent official jobless rate, a "massive increase in the duration of unemployment," and the rise in people who are working shorter hours than they'd like.

Prices for many goods are falling

In April and May, a drop in the cost of gasoline was one key reason for the outright decline in the consumer price index (CPI), reported monthly by the Labor Department. But prices for housing, furnishings, computers, men's clothing, and many food items have also fallen in the past two months.

The price index fell 0.2 percent in May and 0.1 percent in April, and now stands slightly below its January level. On a calendar-year basis, the CPI fell 0.4 percent in 2009 after rising 3.8 percent in 2008.

Falling prices, of course, can be a good thing for many consumers. Not many people complain when prices at the gas pump or the grocery store go down.

But the financial crisis, coupled with its aftermath of high unemployment, has made deflation "Enemy No. 1" for policymakers such as Fed Chairman Ben Bernanke. If deflationary forces took hold, the result can be to amplify the burden of debts (household and public-sector) and to erode economic confidence.

Bernanke: Recovery gaining traction

Mr. Bernanke says the recovery is gaining traction in the private sector. The consensus among forecasters remains that a gradual recovery in the job market will keep incomes rising, despite various headwinds.

But the potential for deflation remains a concern. Another Labor Department report Thursday found that the level of weekly claims for new jobless benefits remains at a high level.

Thus, many economists expect that the Fed will keep its short-term interest rate near zero until some time in 2011. Even with the borrowing rate so low, the Fed policy hasn't fueled a big rise in the supply of money in the US banking system. So forecasters don't see a big risk of inflation picking up in the near term.

One study released this week by the Federal Reserve Bank of San Francisco argues that if the Fed's own forecast for a gradual economic recovery is accurate, the central bank will not have a reason to raise interest rates before early 2012.

In an unusual twist, the price of gold hit a new high Thursday, at $1,248.70 an ounce. Often gold is viewed as a hedge against the risk of inflation. But gold is also an asset investors turn to in times of uncertainty about other assets such as stocks and bonds.

Related:

Businesses 'not hiring' because of economic uncertainty

World debt crisis: eight reasons you should care

Economic recovery: It's up to the private sector now

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