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Friday, June 15, 2007

U.S. Economy: Core Prices Ease, Letting Fed Hold Rate

By Bob Willis and Shobhana Chandra

June 15 (Bloomberg) -- A measure of U.S. consumer prices rose less than forecast in May, evidence that ebbing inflationary pressures may allow the Federal Reserve to keep interest rates unchanged this year.

The 0.1 percent increase in core consumer prices, which exclude food and energy costs, followed a 0.2 percent rise the prior month, the Labor Department said in Washington today. Separately, the University of Michigan reported that consumer confidence fell, and Fed figures gave conflicting signals on the strength of manufacturing.

Bond yields retreated and stocks gained as the inflation number reduced speculation that a rebound in the economy will be accompanied by a surge in prices.

``The inflation risk is relatively limited,'' said Steven Wieting, managing director of economic and market analysis at Citigroup Global Markets Inc. in New York. ``We have an economy that is right in the middle ground. It just doesn't require much from the Fed.''

From a year ago, core prices rose 2.2 percent, the smallest 12-month gain since March 2006, compared with a 2.3 percent gain in April. Economists had projected a 0.2 percent increase from the prior month.

Overall prices climbed 0.7 percent, the biggest increase since September 2005, led by a jump in gasoline costs. They were up 2.7 percent from the same time last year.

``It's still possible that the Fed may adjust rates lower, though right now the Fed is very comfortable on hold,'' said Peter Kretzmer, senior economist at Bank of America Corp. in New York. ``Underlying demand remains moderate, and inflation pressures are generally receding.''

Empire State

The New York Fed's Empire State index jumped to 25.8 in June from 8 in May, while U.S. industrial production was unchanged last month after a 0.4 percent increase.

The Reuters/University of Michigan's preliminary index of sentiment declined more than forecast to 83.7 this month as home values dipped and gasoline held above $3 a gallon. The index reading was the lowest since August and compared with 88.3 in May.

``Consumers are in a sour mood, with gasoline prices above $3 a gallon,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. ``The good news is that consumer spending seems to be holding up better than we would have anticipated.''

Yield Surge

Yields on 10-year Treasury notes surged to the highest in five years earlier this week as investors reassessed prospects for growth, inflation and interest rates. The 10-year U.S. note yield fell to 5.18 percent at 11:25 a.m. in New York. It reached 5.32 percent on June 13.

Economists had forecast consumer prices would rise 0.6 percent, according to the median of 79 projections in a Bloomberg News survey. Estimates ranged from increases of 0.3 percent to 1 percent.

The CPI is the government's broadest gauge of costs because it includes goods and services. A report yesterday showed wholesale prices rose 0.9 percent in May, matching the increase in the cost of U.S. imports reported a day earlier.

Today's report showed energy prices jumped 5.4 percent after rising 2.4 percent in April. Gasoline prices jumped 11 percent.

Regular gasoline at the pump rose to a record $3.23 a gallon on May 23, compared with an average $2.83 in April, according to the American Automobile Association.

Food prices, which account for about a fifth of the CPI, rose 0.3 percent after a 0.4 percent increase in April.

Housing Costs

Housing costs, which include some energy costs and account for one-third of the total consumer price index, rose 0.2 percent. Owner's equivalent rent, which makes up 30 percent of the core CPI, increased 0.1 percent after rising 0.2 percent. Medical-care costs rose 0.3 percent after rising 0.4 percent. Clothing prices dropped 0.3 percent for a second month.

Almost 60 percent of the CPI covers prices that consumers pay for services ranging from airline fares to movie tickets and laundry charges.

Auto prices fell 0.2 percent.

Increased use of ethanol to fuel cars is raising food costs as demand for corn rises, according to economists such as Richard Yamarone of Argus Research in New York.

Dallas-based Dean Foods Co., the biggest U.S. milk processor, said profit this year will be less than it previously forecast because of soaring raw-milk costs.

Direction

Core inflation has been moderating in recent months. The Fed's preferred gauge, known as the core personal consumption expenditures price index, rose 2 percent in April from a year earlier, government figures showed on June 1. That's the smallest year-over-year gain in 13 months.

The Fed, in its latest assessment of regional economic conditions released June 13, said ``reports generally did not indicate an increase in overall prices pressures.''

Policy makers, including Fed Chairman Ben S. Bernanke, have said they would prefer the rate to be in a 1 percent to 2 percent range. The gauge has been at or above 2 percent since April 2004.

Fed Bank of Cleveland President Sandra Pianalto this week reiterated concerns that inflation was too high. The Fed ``has described our core rate of inflation as being uncomfortably high and has stressed the importance of further moderation.''

Fed policy makers had been counting on weaker growth to cool prices. The economy grew 1.9 percent in the first quarter from a year earlier, the slowest since June 2003.

For all of 2007, the economy is projected to expand 2.1 percent, the least in five years, based on the estimates in a Bloomberg survey May 30 to June 7.

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