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Producer Prices Rise 0.5 Percent - More Interest Rate Hikes Likely

Prof. Peter Morici - 7/19/2006

The Labor Department reported the Producer Price Index increased 0.5 percent in June, after rising 0.2 percent in May. Food prices rose 1.4 percent and energy prices rose 0.7 percent. These components of both producer and consumer prices are quite erratic month to month, and Fed policymakers pay particular attention to movements in the core indexes.

Core producer prices—producer prices less food and energy—rose 0.2 percent in June after rising 0.1 and 0.3 percent in April and May.

The 1.4 percent jump in food prices should be viewed together with the 0.5 percent decline in May. Overall, food prices should not play a major role in inflation calculations through the summer and fall.

Wholesale prices for finished consumer goods indicate where core consumer prices are headed. The 0.2 percent increase in core producer price inflation adds weight to Federal Reserve Chairman Bernanke’s concerns that rising petroleum prices are igniting inflation throughout the economy.

Overall, wholesale price inflation continues at a pace that makes the Federal Reserve uneasy, even as economic growth slows. International oil and commodities markets continue to be the most important sources of inflation, but those are beyond the reach of Federal Reserve policy. If the Fed acts too vigorously to contain inflation, it risks a recession and stagflation.

Tomorrow’s consumer price data, which covers a broader range of goods and services, will further illuminate Federal Reserve options. However, today’s producer price data indicate that another interest rate hike is likely, even if it poses considerable risks to growth.

The crisis in Lebanon and Israel has caused unwarranted panic in oil and stock markets. Spot prices for oil averaged about $70 a barrel in June, and are now at about $76. That change should add about 15 cents to the price of a gallon of gasoline and no more than a one-time, 0.3 percent bump to the Consumer Price Index. Considering that gasoline prices were up 73 cents in June from a year earlier, a 15 cent movement will hardly slay economic growth. Other factors, in particular higher interest rates and a flagging housing market, pose greater threats to growth.

If the Middle East crisis does not result in a supply disruption, oil prices should recede once tensions ease, and the crisis should not have an appreciable effect on core inflation this fall and winter. If the Fed does not overact to the recent surge in oil prices, it neither poses an appreciable threat to growth nor to price stability.