Soaring Consumer Prices in 2007. What About This Year?

Whew! Last year's stinging inflation rate won't be repeated this year.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

January 16, 2008

Milder inflation in December should usher in more-moderate price increases this year. Led by food and gasoline prices that galloped upward through most of the year, consumer prices rose a hefty 4.1% from December 2006 to December 2007, the biggest increase since 1990. The pace of inflation abated at the end of the year, however, as gasoline prices went into a dip. For December alone, the Consumer Price Index rose just 0.3%.

2008 isn't likely to see a repeat of last year's inflation performance. While grain, dairy and energy prices will remain high, they won't increase as much as they did in 2007. And we anticipate about a 3% jump in the CPI from December 2007 to December 2008.

Still, that's enough to give the Federal Reserve heartburn, particularly as the monetary policymakers will likely have to disregard their unease about inflation in favor of stimulating the flagging economy by lowering interest rates. The Fed's long-range inflation target is about 2%. Had inflation continued its zoom way past that goal in December, Fed Chairman Ben Bernanke and his colleagues would have been caught in a dilemma. As it is, the more modest December inflation rate gives them more room to maneuver, and another interest rate cut is likely at or before the Fed's next meeting on Jan. 29-30.

One thing that the Fed doesn't have to worry about is inflationary pressure from rising wages. Weak economic growth will result in meager job gains for a while, and unemployment, which jumped to 5% in December, will inch still higher. As a result, wage gains are being constrained, with average hourly earnings up 3.7% in 2007.

The Fed is paying particularly close attention to the core rate of inflation, which excludes food and energy prices and rose by 2.4% for 2007 as a whole and 0.2% in December alone. Although the overall CPI is more relevant to consumers, for whom food and energy are two substantial ongoing costs of living, the core rate is a better indicator of how wide and deeply spread price increases are in the economy. Rents play a large role in the core CPI, and the large number of unsold homes and condos will help keep core inflation at about 2% for the year.

Prices of some major items actually fell over 2007: computers, televisions and other consumer electronics, men's and women's apparel and new cars. But the price declines were easily outweighed by the stiffer tabs not only for food and energy, but also for a variety of other products and services, such as medical care. Health costs, for example, climbed 5.2% in 2007, and we expect an additional 4%-5% increase in 2008.

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