July 18, 2007 (Prices Byte)

By Dean Baker

The core CPI, excluding owner occupied housing, rose at a 2.5 percent rate in the quarter.

The overall CPI rose by 0.2 percent in June, bringing the annual inflation rate over the last quarter to 5.2 percent. This is up from a 2.7 percent rate over the last year, and considerably higher than the 4.0 percent rate of wage increase over the quarter. The core index also rose by 0.2 percent in June, as a 0.5 percent jump in food prices was offset by a 0.5 percent decline in energy prices. The core index has risen at a 2.3 percent rate over the last quarter, almost identical to the 2.2 percent rate over the last year.

One of the biggest factors helping to contain core inflation has been the weakness of the housing market. The vacancy rate for ownership units has soared to a record level in the last year, 50 percent higher than the previous peak. The vacancy rate for rental units is also hovering near the record high set two years ago. As a result, there is considerable downward pressure on rents. The owners’ equivalent rent index (OER) has risen at a 1.9 percent annual rate over the last quarter. This component alone accounts for almost 30 percent of the core CPI. A core index that excluded OER would show an inflation rate of 2.5 percent over the last quarter.

The rent index, which tracks actual rents, has risen at a 3.2 percent rate over the last quarter. The difference is attributable to the fact that the rent index includes utilities, which have considerably outpaced the overall rate of inflation in the last few years.

Another factor holding down core inflation has been a sharp fall reported for apparel prices over the last quarter. Apparel prices reportedly fell at a 4.8 percent annual rate over the quarter. This will be reversed in the months ahead.

The major anomaly on the high side was a jump of 2.5 percent in hotel prices, bringing the annual rate of increase over the quarter to 26.8 percent. While some of this may reflect a real increase, hotel prices are always erratic. It is likely that this index will show declines in future months. Also, there has been a building boom in the hotel sector, which will place considerable downward pressure on prices as new rooms come on line.

The finished goods index continues to show some evidence of price pressures in the pipeline. The overall producer price index fell 0.2 percent, as both food and energy prices declined. However, the core index rose by 0.3 percent in June, following a 0.2 percent rise in May. The core finished goods index has now risen at a 1.9 percent annual rate over the last quarter. While this rate of increase is not especially ominous, it is higher than the 1.1 percent rate over the last six months of 2006. The overall finished goods index has risen at a 5.7 percent rate over the last quarter.

The core intermediate goods index rose by 0.4 percent for the second consecutive month, bringing its rate of increase to 6.6 percent for the last quarter. The rate of increase in the overall intermediate goods index over the quarter has been 10.4 percent. The core crude goods fell 0.2 percent in June. It has increased at just a 1.1 percent rate over the last quarter, but due to sharp increases in prior quarters, it stands 10.2 percent above its year ago level.

On net the price picture continues to be very mixed. There is certainly no story of inflation getting out of control; on the other hand, it does not seem likely that the core CPI will fall to the 2.0 percent target that Bernanke prefers. With somewhat rapid price increases at earlier stages of production (import prices have also been rising more rapidly), and a sharp slowdown in productivity growth in recent years, it seems more likely that inflation will edge higher than lower. The Fed will have to balance the desire for a lower inflation rate with ongoing weakness in the economy, as a sagging housing market and declining real wages continue to crimp demand growth.  

Dean Baker is co-director of Center for Economic and Policy Research in Washington, DC. 

Prices Byte is published each month upon release of the Bureau of Labor Statistics’ reports on the consumer price and the producer price indexes.