December 14, 2007 (Prices Byte)

By Dean Baker

“The 2.8 percent rate of wage growth is far below the rate of inflation."

The overall CPI rose by 0.8 percent in November, the largest increase in more than two years. The biggest factor behind the rise was a 5.7 percent jump in energy prices. However, even the core index rose by 0.3 percent, the largest increase since a 0.3 percent rise in January. The core index has now risen at a 2.6 percent annual rate over the last three months, up from a 2.3 percent rate over the last year. The overall CPI has risen at a 5.6 percent annual rate over the last three months, up from a 4.3 percent rate over the last year.

While the rise in energy prices will not be repeated in the months ahead, and may even be partially reversed, this release, along with the data in the producer and import and export price indexes, suggest that inflation is on an upward path. The acceleration of the core rate of inflation is not driven by anomalies. In addition, food prices also appear to be rising more rapidly on a sustained basis, a development that is consistent with increased export demand, as well as increased demand for biofuels.

The only notable anomaly on the high side in the November data was a 0.8 percent rise in apparel prices. With most import prices now rising, apparel prices may be on a flat or slightly upward path, but this rate of increase clearly will not be sustained. The spurt in apparel prices was offset by anomalies on the low side, most notably a drop of 0.5 percent in the communication component (it has been almost flat over the last year) and a 0.2 percent drop in the lodging away from home index.

There are core components in which energy prices are driving inflation. For example, the 1.8 percent rise in public transportation costs was largely driven by higher fuel prices. Similarly, the 0.4 percent rise in the rent index was driven in part by higher utility prices. Over the last year, the rent proper index (which includes utilities) has outpaced the owners’ equivalent rent index (which excludes utilities) by 1.2 percentage points.  However, these increases are likely to be sustained unless energy prices fall sharply.

The producer price indexes indicate that there is substantial inflationary pressure at earlier stages of production. The overall finished goods index rose by 3.2 percent in November, driven by a 14.1 percent jump in energy prices. The core index rose by 0.4 percent. Over the last three months, the core index has risen at a 1.7 percent annual rate. The core consumer goods index has risen at a 2.6 percent annual rate over the last three months. It had been rising at less than a 2.0 percent rate through 2006 and the first half of 2007. The core intermediate goods index rose by 1.0 percent in November; it has risen at a 5.1 percent annual rate over the last three months.

The falling dollar is clearly a big part of this story. Non-oil import prices rose by 0.7 percent in November after rising 0.5 percent in October. Importers who had been reluctant to pass through the effects of the falling dollar are apparently now raising prices. On the export side, non-agricultural export prices rose 0.8 percent in November after rising 0.5 percent in October. Agricultural export prices have risen by 23.0 percent over the last year.

This month’s price data indicate that the falling dollar is having the expected effect on inflation. While it is not surging out of control, inflation is above the Fed’s 2.0 percent target and will almost certainly head higher in the months ahead, as higher import prices and energy costs get passed on in other sectors. Higher than expected inflation also means that the economy is not performing as well as some analysts had believed. Most notably, the jump in retail sales reported for November appears to have been far more attributable to higher prices than increased sales. Also, the latest data imply that wage growth is falling well behind inflation, which will likely curtail consumption growth in the near future.

Dean Baker is co-director of Center for Economic and Policy Research in Washington, DC. CEPR's Prices Byte is published each month upon release of the Bureau of Labor Statistics' reports on the consumer price and the producer price indexes. For more information or to subscribe by fax or email contact CEPR at 202-293-5380 ext. 102, or morgavan [at] cepr [dot] net.