Pre-Katrina Energy Surge Drives August Inflation

September 15, 2005

September 15, 2005 (Prices Byte)

Prices Byte

Pre-Katrina Energy Surge Drives August Inflation

September 15, 2005
By Dean Baker
A 5.0 percent jump in energy prices in August pushed up the CPI by 0.5 percent for the second straight month. The overall CPI has now risen at a 4.2 percent annual rate over the last three months and stands 3.6 percent above its year ago level. The core (excluding food and energy) inflation rate was still under control in August, with the core CPI rising by just 0.1 percent for the 4th consecutive month. The annual inflation rate in the core index has been 1.4 percent over the last quarter, down from a 2.1 percent rate over the last year.

While core inflation is quite tame at the moment, there are reasons for believing that this will change in the near future. The most obvious reason is that many businesses will be passing on some of the higher energy costs that they were experiencing even prior to Katrina. There is little evidence that this sort of pass through is occurring yet, but businesses will not be able to fully absorb higher energy prices indefinitely. Also, with a tightening labor market, workers should soon be in a position to make up at least some of the losses they have incurred due to higher energy prices.

There were several anomalies in the August data, most of which pushed inflation lower. Apparel prices rose by 1.0 percent after falling sharply the prior three months. Apparel prices are always erratic, so this reversal was predictable. Over the quarter they have fallen at a 2.6 percent annual rate. This is almost certainly sharper than the underlying rate of price decline in apparel, which means that prices will likely rise in the months ahead.

In the opposite direction, hotel prices fell 1.6 percent in August, after a reported increase of 1.2 percent in July. Over the last quarter, hotel prices have fallen at a 1.8 percent annual rate. This component is likely to rise sharply in the next several months.

New car prices fell by 0.5 percent in August after dropping 1.0 percent in July. These declines reflect the big sales by the major manufacturers, which have just ended. There will likely to be some price rises in this component in the months ahead.

Medical care prices were flat for the first time since August of 1973. This was the result of a 0.4 percent reported drop in the price of hospital services, which is almost certainly an anomaly. Similarly, education costs rose by just 0.2 percent, the smallest increase since December of 2001. This is likely to imply sharper increases in the future. Education costs have risen 6.1 percent over the last year.

Rental costs continue to be well contained, showing that the run-up in home sale prices is not due to fundamentals in the housing market. The rent index rose by 0.3 percent in August, while the owners equivalent rent index (OER) rose by just 0.2 percent for the third consecutive month. The OER index is the best measure of rental values because it strips away utility costs that have pushed the rent index higher. It has risen by just 2.2 percent in the last year. 

The August data show little evidence of inflationary pressures at earlier stages of production, apart from surging energy prices. The overall finished goods index rose by 0.6 percent in August, but the core index was flat. The core index has risen at a 1.3 percent annual rate over the last quarter. However, the big sales on cars, which comprise 10 percent of the core index, played a substantial role in restraining finished goods prices.

It is likely that the September price data will look considerably worse than the August data. The anomalous factors holding down inflation in recent reports are likely to push it higher this fall. In addition, businesses are likely to start passing on some of the higher energy costs that they have experienced in recent months. On top of this, a tightening labor market is likely to lead to faster nominal wage growth so that workers at least come close to keeping pace with inflation. 

Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.

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

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