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Core Inflation Slows, Fed Should Stand Pat and Stock Prices Should Surge

Prof. Peter Morici - 11/20/2006

Thursday, the Labor Department reported that the Consumer Price Index fell 0.5 percent in October, after falling 0.5 percent in September.

Seasonally adjusted, food prices were up 0.3 percent in October, after rising 0.3 and 0.4 percent in September and August. Energy prices fell 7.0 percent in October, after falling 7.2 percent in September and rising 0.3 percent in August. Also, transportation and apparel prices fell 3.1 and 0.7 percent, respectively.

The Federal Reserve has been particularly concerned about the pass through into other sectors of higher petroleum prices, which surged from March through August, and pressures from labor market pressures. Federal Reserve policymakers pay close attention to movements in the core consumer price index, which strips away direct energy costs and food prices.

Core consumer prices rose 0.1 percent in October, after rising 0.2 percent in July, August and September. Since October 2005, core consumer prices have risen 2.7 percent, and the compound annual rate of change for the three months ending in October was 2.3 percent.

Now the outlook is for core inflation to fall within Ben Bernanke’s target range of one to two percent. The Federal Reserve should not change interest rate policy before its March meeting, and economic growth should recover to between 2.5 and 3 percent by the first half of next year.

Holiday shopping should give retailers a boost, and along with more robust commercial construction and business investment, sustain the economic expansion.

All of this is great news for the stock market.

Falling energy prices, moderating inflation and decent holiday sales will strengthen corporate profits and investor confidence.

If the new Democratic majority in Congress does not spook the bond and equity markets with talk of broad spending initiatives, new taxes, or overly aggressive business regulations, the stock market rally should continue into the New Year.

Household savings performance will improve, and ordinary investors should shift from buying bigger homes to investing in stocks. Stock prices should surge.

The biggest surprise of 2007 will be the resilient bull market.