Inflation a top threat to economy

Consumer prices have risen at a 5.5 percent annual pace for the past three months, rippling from plywood to dairy section.

A cab ride in New York now costs 26 percent more than it did a year ago.

In Omaha, Neb., the price of Oxboard, a stronger form of plywood, is up 187 percent over the past six months.

Since January, buying a $10,000 used car has cost about $320 more. Don't even mention the price of anything sold by the gallon.

If you think things are getting more expensive, you're right. While two months ago jobs were the biggest worry, inflation is now emerging as one of the main threats to the US economy.

This was reaffirmed Tuesday when the US Labor Department reported consumer prices rose 0.6 percent in May - the largest increase since January 2001. Over the past three months, consumers have seen prices rise 5.5 percent on an annualized basis - the highest inflation rate since the late 1990s.

"This isn't pretty," says Bob Gay, chief economist at Commerzbank Securities in New York.

Rising inflation, in effect, acts as a tax on consumers, reducing the amount of money they have to spend on vacations, gifts, and trips to the mall. If it were to continue, it would affect the stock and bond markets, which generally react negatively to inflation. And the higher inflation rate probably ensures that the Federal Reserve will hike interest rates at the end of the month. Most economists expect the Fed will only hike rates by 0.25 percent. But the inflationary pressures mean this probably won't be the only rate hike.

"This is only a warm-up," says Mr. Gay.

In the past, the Federal Reserve has tended to discount inflation when it takes place in food and energy, considered to be volatile commodities that often reverse themselves over time.

"Sustained price increases are usually followed by declines, and they are beyond the control of policymakers whether it's war in the Mideast or mad cow disease," says Richard DeKaser, chief economist at National City Corp. in Cleveland.

In fact, on the energy front, that has happened to a minor extent over the past week. Gasoline prices have dropped around 7 cents a gallon, reflecting lower crude oil prices as OPEC has started to ramp up production. If pump prices continue to fall, as some expect, this would lower energy costs, which are up 30 percent over the past three months.

Still, some economists are wondering if this year the Fed might have to reconsider this strategy. There is concern that energy costs will spread throughout the economy. Almost everything from plastics to medicines requires some form of petroleum input.

"The longer the price stays up, the greater the impact on the whole economy," says Sung Won Sohn, chief economist at Wells Fargo Banks in Minneapolis. "Maybe we're at a point where the Fed starts to look at the overall inflation rate."

Rising cost of a kitchen

For many Americans, the official inflation numbers may not tell the whole story. For example, millions of people will be buying a new home or redoing their kitchens this year. Yet the government's CPI numbers view the cost of housing in terms of rent, which is up 5.6 percent year over year. "For someone who is buying a new house or remodeling one, that is not remotely close or representative of the costs," says Gay. "I know. I've just renovated two of them and the costs are astronomical."

Building a new house is also becoming more expensive - everything from lumber to sewer pipe to cement is going up. For the first quarter of the year, the National Association of Homebuilders estimates it cost about $7,000, or 3 percent more, to build a new house.

Dan Pearce of Pearce Homes in Omaha, Neb., ticks off higher prices for everything from copper wire to gypsum. Among the steepest increases he's seen: the steel used in garage doors and structural beams, as well as the appliances that consumers want in new homes.

But one of the biggest increases is for Oxboard sheeting - which is being shipped in great quantities to Iraq for the rebuilding effort. Over the past six months, the price has soared from $11 to $28 a sheet. "You could easily see 500 sheets in the type of home I would be involved with," says Mr. Pearce. "You have to pass that on."

Transportation is one of the fastest-growing segments of the CPI, up 1.7 percent for the month and 12.4 percent for three months. This would include the cost of gasoline, jet fuel, and diesel.

Watch that old Ford

Yet used-car prices are showing signs of rising, too. Tom Webb, an economist with Manheim Auctions in Atlanta, says the company's index bottomed out about a year ago. Since then, used car prices have climbed 5 percent. (The government says used car prices are down 11 percent over a year ago - a number that Mr. Webb thinks is way off.)

The dominant reason for the higher prices, says Mr. Webb, is the reduction in the number of cars being leased. Leased vehicles typically get turned in more frequently than purchased cars, adding to the inventory of vehicles on used-car lots. But with zero-percent financing, many consumers are deciding to buy rather than lease, he says.

Hotel prices are rising as well, affecting Americans' travel plans. With the slow economy last year, hotel chains were offering discounts to attract travelers. This year, the discounts disappeared and prices have risen 5.5 percent in the past three months. "The end of a discount is the same as a price increase. It costs you more," says Gay.

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