Inflation's rising toll on consumers

It's not just high energy bills. Even everyday items rose more than expected last month.

The US economy is remarkably strong and buoyant, but high energy prices and rising interest rates are starting to take a toll on consumers.

• The pace of home-mortgage applications is down 15 percent, compared with this week a year ago, as "for sale" signs stay up longer in a slowing home market.

• Half of Americans have changed their vacation plans to stay closer to home, according to an Associated Press/Ipsos poll this month.

• Prices beyond the gas pump are also edging up. The "core" consumer price index (CPI), which excludes volatile food and energy costs, surprised analysts by jumping 0.3 percent last month, according to a government report Wednesday.

These pocketbook pressures don't signal a return of "stagflation" - the harsh blend of recession and rapid inflation that surfaced three decades ago.

But they do represent an economic climate less friendly to consumers - a gray zone where the pace of economic growth may be slowing even as the threat of inflation remains in the foreground.

"It's finally caught up" to average Americans, says economist Michael Cosgrove, who publishes The Econoclast newsletter in Dallas. "The cost of credit has gotten to a level where it's starting to impact people's decisions negatively."

This represents a reversal from just a few years ago, when gas was cheap, the interest on a fixed-rate mortgage was below 6 percent, and home prices hadn't yet soared to today's peaks.

The new head winds also include a weakening dollar, which eats away at Americans' spending power for imported goods or foreign travel.

In short, prices have gone up for several key items: credit, foreign currency, housing, and the fossil fuels that are a basic cost for virtually every home and business.

All this explains why indexes of consumer confidence have sagged in recent weeks, despite signs of healthy economic growth and a strong labor market.

It's a confusing period even for Federal Reserve policymakers, now weighing whether additional interest-rate hikes are needed to stamp out inflation, or whether the pinch on consumers is already starting to slow the economy to a sustainable pace of growth.

"Clearly we are seeing a slowdown in housing," and autos sales are weak, says Ed Yardeni, chief economist at Oak Associates in Akron, Ohio. Yet "it takes a while for interest rates to get to levels that really bite." Indeed, many forecasters see the economy growing at a still-solid 3 percent pace in the second half of the year, as exports and business investment help make up for possibly weaker consumer spending.

Against this backdrop of uncertainty, the Fed may decide to hold off before hiking interest rates further, to see how consumers fare in the months ahead.

But Wednesday's inflation report prompted new concern. Stock prices fell sharply on the expectation that the Fed may need to boost interest rates further at its June meeting to prevent consumer prices from spiraling out of control. Still, some analysts remain hopeful that the Fed can steer a steady course between inflation and downturn: The economy may be less cyclical than in the past, when interest-rate hikes often prompted sharp housing downturns and then recessions.

It's possible that could happen again. Builders this week posted a third straight monthly drop in new-home starts, a key indicator of the current housing slowdown. And home prices in some markets are lower now than at the end of last year.

But bank credit is not drying up as it sometimes has in the past. At 6.6 percent, the interest on a 30-year fixed rate mortgage still makes many homes affordable by historical standards.

The rising cost of housing was one factor behind Wednesday's rise in the consumer price index.

Costs of shelter, clothing, and healthcare all rose in April, pushing the core rate of inflation up 0.3 percent for the month, higher than the 0.2 percent rate expected by forecasters. That means the core rate is now advancing at a 3 percent pace, up from a 2.2 percent rise for last year.

Consumer prices overall, driven by rising energy costs, are heading up at a 5.1 percent annual pace. They rose 3.4 percent last year.

Those energy costs are top of mind for many consumers.

"I would say that it's the biggest thing right now" driving consumer sentiment, says Raghavan Mayur of TechnoMetrica Market Intelligence in Oradell, N.J., a pollster who conducts the monthly TIPP survey of economic optimism.

It goes beyond sticker shock at the pump, he says. "They feel that their economic security is threatened" by America's reliance on the world oil market.

Not many people will cancel vacation plans outright due to fuel prices, predicts Sean Comey, a spokesman for AAA of Northern California in San Francisco.

But many are planning shorter trips, and coping with rising airfares by buying night or midweek tickets.

The good news for consumers is that their incomes may be going up, thanks to a tightening labor market. "Thirty percent of [business] owners say there's at least one opening they can't fill," says William Dunkelberg, chief economist at the National Federation of Independent Business.

But recent surveys, he adds, show that businesses are starting to pass higher labor costs along in the form of higher prices. "It's not good."

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