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Daily Global Commentary

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Advancing Core Inflation Seals the Outcome of March FOMC Meeting

Sat, Mar 17 2007, 03:26 GMT
by Asha Bangalore

Northern Trust

The Consumer Price Index (CPI) moved up 0.4% in February after a 0.2% increase in January. The 0.9% increase in energy prices and a 0.8% jump in food prices were the large gains that accounted for the sharp increase in the overall CPI. Going forward, energy prices are likely to post an increase again in March. According to the BLS, over three-fifths of the February advance in food prices was attributable to a 4.7% increase in the index for fruits and vegetables.

Bad weather in California led to higher prices of fruits and vegetables. This should show some moderation or be reversed in the months ahead. Year-to-date, the CPI has risen at an annual rate of 3.3% vs. a 2.5% increase in 2006.

The core CPI rose 0.2% in February, putting the year-to-date gain at 3.0% and the year-to-year increase at 2.7%. Medical care expenses advanced 0.5%, after a 0.8% jump in January. Medical care commodities price index dropped 0.3%, while medical care services price index advanced 0.7%. Shelter costs moved up 0.3% and apparel prices rose 0.5%. Within shelter, the index for rent increased 0.4% and owners’ equivalent rent rose 0.3%. Prices of new cars fell 0.1%, airfares rose 0.9%, and the tobacco price index was up 1.0%.

Incoming data present a mixed picture of the economy, with core inflation still exceeding the FOMC’s comfort zone. Retail sales were noticeably soft in February, employment numbers for February were weak on all fronts, and latest jobless claims data point to persistent sluggish labor market conditions. Despite these indications, the 2.7% year-to-year change in the core CPI and the tone of factory production data allow the Fed to maintain the current hawkish stance. Although the pickup in momentum in the factory sector appears temporary as more recent regional factory surveys for March suggest moderation in the pace of activity, the FOMC will need additional validation from weak factory production in the months ahead to modify concerns about resource utilization. The Fed will be on hold at the close of the March 20-21 FOMC meeting and the policy statement will probably include only minor changes.

Gain in Factory Production Appears As Temporary Event

Industrial production increased 1.0% in February, after a 0.3% decline in the prior month. A part of the sharp increase was due to a 6.7% jump in production at the nation’s utilities which was brought about by colder-than-average temperature in February. In addition, an increase in production of motor vehicles (+4.5%) and in high-tech industries (+3.1%) contributed to the pick up in momentum in the factory sector. Total factory production rose 0.4% during February after a 0.5% drop in the previous month. The operating rate of nation’s factories rose to 80.1 in February from 79.9 in January.

The operating rate of the factory sector is one of the major indicators on the Fed’s watch list in its fight against inflation. Factories used 80.1% of their capacity in February, which is a tad higher than the average of 79.8% for the period 1972-2006. The Fed has time and again cited the rising pace of resource utilization as source of inflation. The Fed is likely to cite the pickup in the operating rate as one of the reasons to stay on the current course at the close of the March 21 FOMC meeting.

Consumer Sentiment Index Dips In March

The University of Michigan Consumer Sentiment Index fell to 88.8 in the early-March survey from 91.3 in February. Both the Expectations Index (79.3 vs. 81.5 in February) and the Current Economic Conditions Index (103.6 vs. 106.7) dropped. The Consumer Sentiment Index has declined in four out of the last six months. If employment conditions fail to improve, it should not be surprising to see a further drop in consumer optimism.

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Published on  Sat, Mar 17 2007, 03:27 GMT