Inflation index may calm Fed

Yesterday's figures showing stable prices suggest that rate hikes might not be needed.

For the past five years, the US economy has been revving along the fast lane. Now, there are signs that it's starting to throttle back, at least temporarily - an event that could mean the Federal Reserve Board can hold off another interest-rate hike later this month.

The latest evidence that could help keep the Fed on the sidelines came yesterday, when the Department of Labor reported the consumer price index (CPI) rose only 0.1 percent in May. This suggests the underlying rate of inflation has moderated - the goal of recent Fed tightening.

"If the CPI had been a bad number, you could argue the Fed could be more aggressive about tightening even though there are a lot of signs of a slowing economy," says Stan Shipley, an economist with Merrill Lynch & Co. in New York. "Now any interest-rate increases are probably on hold."

Despite current weakness in sectors such as housing and retail, economists caution that the economy may still have some pop left in it. They would not be surprised to see a resurgence of spending again this summer, after consumers catch their breath. "There is a good possibility of one further round of tightening in August when the Federal Reserve meets again," says Paul Kasriel, an economist at Northern Trust Company in Chicago.

June inflation numbers are also likely to be worse, reflecting the latest rise in gasoline prices. Since the beginning of June, the price of gasoline has increased 11 cents a gallon.

"As a central banker, you worry that higher energy prices will spill over to other things," says Lyle Gramley, a former member of the Federal Reserve Board, now a consulting economist with the Mortgage Bankers Association.

Mr. Gramley believes there are other reasons it's too early for the Federal Reserve to celebrate. Construction in the first quarter surged because of good weather.

This resulted in less construction in the second quarter. The same is true with consumer spending. Following a big splurge, there is almost always respite. And the stock market, after falling, is now higher again. "These are difficult indicators to interpret," says Gramley.

Shopping spree slows down

Over the short term, the numbers are beginning to look like the economy is moderating. On Tuesday, the government reported retail sales in May were off 0.3 percent after falling in April. Spending is off on such durable goods as autos, furniture, and household appliances.

It's not surprising the economy is slowing. The Fed, which meets on June 28, has raised interest rates 1.75 percentage points in less than a year. The latest interest rate increase of one-half a percent in May has not even ratcheted through to the economy. This will start to happen in the fall. Even so, home builders and auto dealers are now starting to notice less business.

"The high interest rates deter demand for durable goods more than services. That's why we see less spending on cars, which are primarily paid for by financing, and less demand for durable goods such as furniture that goes into housing," says Gordon Richards, an economist at the National Association of Manufacturers in Washington.

Economists have long predicted consumers would start to tire of days and nights at the mall. In the first three months of the year, consumers, aided by early tax returns and mild weather, had boosted retail spending by about 8 percent. Now, Merrill Lynch estimates consumer spending has slowed to about a 3.5 percent annual rate.

Economist Mark Vitner of First Union Bank in Charlotte, N.C., says the drop in retail spending would have been even more dramatic were it not for the sharp rise in gasoline prices. Prices are up 23.8 percent over the past three months. "The run-up in gas prices should act like a tax increase, it should work to slow the economy itself," says Mr. Vitner.

Past interest rate hikes are already acting like a brake on the housing market. This Friday, the government will report housing starts for May. Dave Seiders, chief economist at the National Association of Home Builders (NAHB), expects they will show about a 6 percent decline, coming after another 6 percent decline in April. His survey of very large builders suggests the tapering off is continuing. "From the Fed's point of view, housing is cooling," he says.

Lower demand

There are signs that manufacturing is also motoring down. Earlier this month, the National Association of Purchasing Management reported that, for the first time in 15 months, order backlogs are declining.

"The evidence is pretty clear in manufacturing that the high interest rates are starting to deter demand," says Mr. Richards.

Further evidence of this should come today when the government reports on May industrial production. Economist expect to see production fall for the first time since November 1998. "The slowdown is quite pronounced," says Richards.

(c) Copyright 2000. The Christian Science Publishing Society

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