CPI drop fuels rate cut talk

Plunging prices, especially in energy, lead to the largest drop in the CPI since 1986 and leave the Fed room for more rate cuts.

©New York Times

© St. Petersburg Times,
published August 17, 2001

The prices that American consumers paid for goods and services fell in July at the steepest rate in 15 years, as gasoline prices plummeted, the Labor Department said on Thursday.

The report provided further evidence that inflation remains under control, even though the Federal Reserve has reduced interest rates six times this year to reinvigorate the economy.

On a seasonally adjusted basis, the department's consumer price index dropped a surprising 0.3 percent, well exceeding economists' forecasts of an 0.1 percent drop. It was the first decline since April 2000 and the largest since one of 0.4 percent in April 1986.

Excluding food and energy prices, the core inflation rate was only 0.2 percent, even with a large spike in tobacco prices.

The negligible inflation in July would appear to give the Fed's policymakers further room to reduce short-term interest rates again when they meet Tuesday. Several economists said they expected the Fed to reduce its target rate for overnight loans between banks by another quarter of a percentage point, to 3.5 percent. But some warned that the Fed may have to raise rates again to stave off inflation when the manufacturing side of the economy begins to rebound.

"Inflation is not an issue, in the short-term, for Fed policy," said Jade Zelnik, chief economist at Greenwich Capital Markets. "Purchasing power is being improved by falling gasoline prices."

The cost of gasoline fell 11 percent in July, its sharpest drop since a decline of 11.2 percent in April 1986. Overall transportation prices fell 2.3 percent, offsetting increases in the costs of many other services, including education, communication, medical care and recreation.

The cost of food and beverages increased 0.3 percent, while apparel costs fell 0.6 percent and housing costs were unchanged.

In the services segment of the economy, where wages are the most important determinant of prices, businesses have retained the ability to charge higher prices. But manufacturers, free to open factories overseas to cut costs, have had trouble pushing price increases through to consumers as demand has slowed.

For the 12 months ending in July, consumer prices rose 2.7 percent, compared with a rate of 3.6 percent in the 12 months ending in July 2000. By the same measure for the same time periods, prices of services rose 4.2 percent, compared with 3.6 percent a year earlier.

"There's still a lot of question marks about the economy, particularly investment spending," said Joel Prakken, the chairman of Macroeconomic Advisers, a consulting firm in St. Louis. Still, he said, it appears that the year's "second half if going to be a heck of a lot better than the first."

In a separate report, the Commerce Department said the housing market remained strong in July, with starts of new construction rising 2.8 percent, to an estimated 1.67-million, from a revised 1.63-million in June.

"With housing activity a good leading indicator for durable consumption, and the economy balanced two to three quarters since the start of monetary easing, housing gains may point to stronger consumption ahead," wrote Peter Kretzmer, senior economist at Banc of America Securities, in a note to clients.

The Labor Department also reported that the number of people filing initial claims for unemployment benefits in the week of Aug. 11 fell by 8,000 to a seasonally adjusted 380,000.

Though the Fed is expected to cut interest rates again next week, it may "have to backpedal furiously as the economy starts to recover," said Bill Cheney, chief economist of John Hancock Financial Services. "The tightening cycle may happen sooner and faster than people expect."

In a separate poll conducted by ABC News and Money magazine, public confidence in the economy dipped to its lowest level in four years. Less than half of Americans in the consumer survey -- 49 percent -- rate the nation's economy as excellent or good. That's the first time the public's positive rating has slipped below 50 percent since May 1997. The survey is based on telephone interviews with about 1,000 adults a month and has an error margin of plus or minus 3 percentage points.

- Information from the Associated Press was used in this report.

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