There is sufficient evidence for the FOMC and other Fed officials to modify their rhetoric highlighting concern about inflation. Here is a list of latest developments to keep track of events prior to the December 12 FOMC meeting.

(1) Most important evidence: The core Consume Price Index (CPI) rose 2.7% on a year-to-year basis in October, down 20 basis points. The overall CPI rose 1.3% on a year-to-year basis in October compared with a high of 4.3% increase in June 2006. Lower energy prices helped to bring down the overall CPI.

The FOMC’s preferred measure of inflation, the personal consumption expenditure chain price index excluding food and energy, rose 2.42% in September on a year-to-year basis, after a cycle high mark of a 2.48% increase in August. The October reading of this inflation measure will be published on November 30. As charts 1 and 2 show, core inflation is moving in the desired direction.

(2). Retail sales have now dropped for two months and held steady for one month during the three months ended October. Lower prices for gasoline contributed to the drop in retail sales. Excluding autos and gas, growth in retail sales show a significant deceleration (see chart 3).

(3) Needless to say, housing market data send additional signs of deterioration. Starts of new homes fell 14.6% in October to an annual rate of 1.486 million units. On a year-to-year basis, starts of new homes are down 27.2%, the largest decline since March 1991. Permits for the construction of new homes fell 6.3% to an annual rate of 1.535 million units in October, the lowest since level since December 1997, and the ninth consecutive monthly decline in extensions of permits. Is this the bottom for construction of new homes? Unfortunately, there is evidence that suggests that additional declines in the construction of new homes cannot be ruled out. In past housing downturns, the average peak-to-trough decline in housing starts has been 47%. In the current downturn, starts are down 34% from their January 2006 peak. So, unless this is a less exaggerated housing cycle than average – and there is plenty of evidence to suggest the opposite – the housing recession still has room to run.

(4) Factory production has dropped for two consecutive months and the year-to-year change has slowed to a 4.1% increase after a likely cycle high of a 6.4% gain in September.

(5) Consistent with slowing economic conditions, inventories at the nation’s factories, wholesalers, and retailers are growing. The inventories-sales ratio rose 3 notches to 1.50 in September (see chart 6). This is possibly the beginning of a more serious setback.

The FOMC has been speaking tough on inflation for a long time, including in the minutes of the October meeting. This might have been justifiable given the upward trend of core inflation, notwithstanding the fact that inflation is a lagging economic process. Core inflation is now moderating and other real economic data show the impact of a 425 bps higher federal funds rate. Prior to the December 12 FOMC meeting, employment data, auto sales, and ISM survey for November will be available. If these numbers continue to paint a picture of weak economic conditions, it should not be surprising to see a policy statement warning markets of the need to lower the federal funds rate in the months ahead.