US consumer price slowdown raises deflation fears
Friday May 16, 5:12 pm ET
By Eric Burroughs
(Updates with closing market levels, adds Fed comments, detail)
NEW YORK, May 16 (Reuters) - Fresh evidence of flagging inflation and a slowdown in the robust housing market in April fanned fears on Friday that deflation could further undermine the already struggling U.S. economy.
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The core Consumer Price Index rose by an unexpectedly weak 1.5 percent in April, its slowest year-over-year rate in 37 years and a fraction of last year's healthy 2.5 percent pace.
While the possibility of falling prices may appeal to consumers, deflation can cripple economies as businesses and individuals expect prices to keep falling and so refrain from investing or spending, causing asset values and incomes to shrink.
The specter of deflation, so far mostly confined to goods rather than services like medical care, has boosted speculation the Federal Reserve may have to cut interest rates sooner rather than later to prevent sliding prices from derailing the economy.
On a monthly basis, the core CPI was flat for a second straight month -- the first time since 1982 the core measure hasn't risen in any two consecutive months. Economists had expected core CPI, which excludes volatile food and energy prices, to rise 0.2 percent.
The overall index actually fell 0.3 percent in April but, like the big drop in wholesale prices reported a day earlier, it was driven down by a big slide in oil prices since the start of the Iraq war eased anxiety of supply disruptions.
Analysts said the figures raised the prospect that a further slide in prices could eventually ensnare the U.S. economy like it has in Japan, where a decade of economic stagnation has led to deflation for the last four years.
To counter the anxiety, Federal Reserve Vice Chairman Roger Ferguson said on Friday the central bank will be "on guard" against further declines in inflation and that the possibility of deflation is "quite remote."
"Quite simply, the United States has too many good things going for it to make a forecast of deflation credible," he said.
Still, the deflation worries sent the S&P 500 (CBOE:^SPX - News) a quarter percent lower, while U.S. Treasuries kept up their rally. The topic is likely to be hot as finance ministers from the world's leading industrialized countries gather in France this weekend.
A further decline in inflation would enhance the return on fixed-coupon Treasuries, and on Friday the benchmark 10-year note yield fell to a new 45-year low of 3.42 percent.
The $10 trillion U.S. economy is also unlikely to get much help for growth and inflation from foreign demand of its goods and services, even as the dollar's sharp decline has made its exports cheaper. Data showed this week the economies of both Europe and Japan stalled in the first quarter.
THE DREADED "D" WORD
Last week the U.S. Federal Reserve said in its policy statement it was worried about an "unwelcome substantial fall in inflation," a historic departure from its long fight to bring down inflation.
The Fed's words stoked expectations the central bank could cut official interest rates when it next meets in June. The overnight federal funds rate, used by banks to lend to each other money, already stands at a four-decade low of 1.25 percent.
"The CPI report strengthens the case for a rate cut by the Fed at their June 24-25 meeting," said John Shin, an economist at Lehman Brothers.
In a ray of hope amid the gloomy data of late, consumer sentiment rebounded for a second straight month in May as the recent rise in stock markets made households feel more confident about the future.
The University of Michigan's index of consumer sentiment rose to 93.2 in May from 86.0, easily beating the forecasts of economists for a rise to 86.9. The survey found that for the first time since last June, more households were looking for better times ahead rather than worse.
Still, what matters more with consumers is their spending, which makes up two-thirds of the economy. In April, retail sales excluding automobiles posted their biggest drop since September 2001. A deeper retrenchment in consumer spending would undermine growth and cause inflation to slow even more.
A major factor causing deflation is the economy's vast unused production capacity. Without robust growth to absorb the slack, the pace of inflation will continue to decline.
The Fed said on Thursday capacity utilization at factories, utilities and mines fell to a 20-year low of 74.4 percent in April. The one missing ingredient for a full-fledged recovery is stronger capital spending as the economy still grapples with the hangover of the late-1990s investment bubble.
Friday's CPI report showed price declines almost across the board. Housing prices dipped 0.1 percent, the weakest reading since October 2001, right after the Sept. 11 attacks. Apparel costs slid 0.6 percent.
Even the roaring housing market cooled in April. Housing starts fell a surprisingly hefty 6.8 percent, largely due to a decrease in groundbreaking for new multifamily homes. But the housing news wasn't entirely bad. Permits, an indicator of builder confidence in future sales, rose 1.2 percent on the month.
"The core of housing is still very strong," said Joseph LaVornga, senior U.S. economist at Deutsche Bank Securities.
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