Inflation Likely to Stay Tame This Year

But the lower-than-expected rise in May prices looks better than it really is.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

June 17, 2009

Inflation is a bit worse than the latest government report indicates, largely because seasonal adjustments tend to understate the true effect of energy prices. Gasoline rose 9.6% in May, but about two-thirds of that is expected this time of year, so officials make an adjustment that lowers the impact of gasoline.

The problem is that oil is going to spike over the next couple of months, to about $85 a barrel by mid-July, pushing gasoline to about $3 a gallon. It’ll drift lower after the summer, ending the year at about $65 a barrel, with gas down to $2.25 a gallon. The higher energy prices will mean less for consumers to spend on other goods.

Because of the oil surge, we’re raising our inflation estimate for the year from 1% to 1.5%, after a 0.1% increase last year.

Other prices were contained in May, with the overall Consumer Price Index up a scant 0.1%. The food and beverage index, for example, fell 0.2%, with food at home dropping 0.5%, the sixth straight monthly decline. Apparel fell for the third month in a row. Also falling were airfares. Overall medical costs rose only 0.3%, with an exception in prescription drugs, which rose 0.6% on the heels of a 0.5% increase in April.

While there's no question that the prices of oil and gasoline are rising, those costs aren't working their way into various consumer goods and services because the recession battered economy has plenty of slack.

Unemployment continues to rise toward 10%, and much factory capacity is idle. "There's weak pricing power and no pressure on wages," says Bruce Kasman, chief economist for JPMorgan Chase. Along those lines, in its June survey of small businesses, the National Federation of Independent Business found that "price cutting has been widespread and very few owners expressed an intent to raise prices in the coming months."

The core inflation rate, which excludes food and energy, also increased 0.1% in May, easing a bit from 0.3% the previous month, a blip driven largely by higher tobacco prices.

With oil and other commodity prices on the rise, talk earlier this year about the threat of deflation is a distant memory. Across-the-board falling prices remain unlikely, though year-over-year the CPI has declined 1.3%. That’s the biggest decline in 60 years, an attention grabbing -- but very backward looking -- statistic.

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