A big drop in fuel prices and a rise in the dollar are providing a breath of fresh air for the economy, easing inflation and re-energizing consumer buying power at a critical time when the boost from tax rebates is fizzling.
Oil prices have dropped more than 20 percent in the past month, while the dollar has gained more than 8 percent against other major currencies. The dollar’s rally has sparked hopes that the U.S. economy is finally emerging from a five-year downward spiral that was feeding inflation at the same time it was zapping domestic growth.
The sea change came just as U.S. inflation hit a 17-year high of 5.6 percent last month, driven by surging energy and food costs that are tied to the global commodities markets, the Labor Department reported Thursday. The flare-up in prices sent inflation-adjusted wages down by 2.5 percent in the biggest drop since 1980.
“Consumers have been suffering under the worst of the drag from the spike in energy prices” that drove gasoline prices to record levels above $4 a gallon in early July, said Stephen Stanley, chief economist at RBS Greenwich Capital. “The good news is that this negative should begin to fade as summer ends, given the pullback in prices at the pump” of more than 30 cents a gallon since then.
Consumers say they are relieved about the drop in gas prices, but they are not uncorking the champagne just yet. “$3.50 per gallon is welcome in light of recent prices,” said New Jersey motorist Joe Kramer, “but it is far too expensive if it becomes a bottom. That will not loosen most drivers’ purse strings.”
Overseas travelers also stand to benefit from more favorable exchange rates against a slew of currencies in countries ranging from Canada and Mexico to France, Germany, Japan, Australia, Brazil and New Zealand.
Mr. Stanley noted that consumers are getting a break just as the stimulus from tax rebate checks is ending. The rebates helped bolster spending in the spring and particularly boosted sales at discounters like Wal-Mart, where people were able to readily exchange their checks for merchandise. But retailers report that sales have slowed sharply since June, while auto sales last month hit the lowest levels in 16 years.
Consumers also are being weighed down by further turmoil in the housing and credit markets and a sharp rise in joblessness, Mr. Stanley noted. The department Thursday reported that claims for jobless benefits jumped to a six-year high of 440,000 in the past month — a level often associated with recession.
“This toxic combination explains why we look for a modest decline in real consumer spending in the second half of the year, which would be the first ‘consumer recession’ since 1990-91,” Mr. Stanley said.
While the break in inflation pressures is helping the U.S. economy and consumers, it ironically is partly a result of U.S. weakness spreading to other major economies around the world. Reports out this week showed that major economies in Europe and Japan shrank in the past quarter and may be headed toward recession. The U.S. economy shrank in the final quarter of 2007 and also has been flirting with recession this year — so now all the developed nations are in the same boat.
“Things do not look promising in Europe and Japan” where growth was stronger earlier in the year, and that is why the dollar is resurging in global currency markets, said Steven Englander, a currency analyst with Lehman Brothers.
“We are increasingly convinced that a cyclical turn in the dollar is occurring after a seven-year decline,” he said, citing not only a more favorable outlook for U.S. inflation as oil prices decline, but a strong turnaround in the U.S. trade deficit that has helped to stem the downward trend of the dollar.
The dollar became “hyper-competitive” against the euro and other currencies as it sank to record lows earlier this year, spawning a buying binge in U.S. goods and assets by overseas investors and consumers that will continue to lift the dollar, possibly for years to come, he said.
“The greenback is back on top,” said Tobias Davis, a currency specialist at Custom House, a Canadian investment company, but he said the spike in U.S. inflation this year is complicating matters for the dollar.
“To the markets’ relief, energy and commodity prices have been easing as of late,” he said, “[but] will it transpose into a lower inflation reading” in coming months? Mr. Davis said he fears “price pressures will remain a headache” for some time to come despite the downturn in oil prices.