- The Washington Times - Saturday, October 22, 2005

The September inflation details released in recent days were staggering. In the wake of Hurricane Katrina, bad news was expected, to be sure. But the reality was staggering all the same, particularly because the actual numbers exceeded the woeful forecasts.

Perhaps most worrisome is the strong indication that the impact of soaring energy prices this summer, especially the price of gasoline, has embedded itself in the psychology of consumers, causing inflationary expectations to accelerate rapidly. These rising expectations have already lifted the interest rate on the 10-year Treasury note from less than 4 percent in early June to nearly 4.5 percent today. If heating bills this winter jump 50 percent to 70 percent as expected, inflationary expectations could take another leap, sending long-term interest rates higher still. Such developments on the crucial inflationary-expectations front would require strong reaction by the Federal Reserve, which has raised its benchmark short-term interest rate by 2.75 percentage points since June 2004.

The consumer price index (CPI), which is the most popular measure of inflation, increased by 1.2 percent in September, the largest monthly rise in more than a quarter century. Over the past 12 months, consumer prices have now risen by 4.7 percent, which is the fastest 12-month increase since June 1991. For the first nine months of 2005, the annualized rate of consumer-price inflation was 5.1 percent. Thus, inflation, which increased from 1.9 percent during 2003 to 3.3 percent during 2004, continues to accelerate.

Over the past three months, the trend has become especially bad. The blockbuster 1.2 percent increase in consumer prices for September followed stiff increases of 0.5 percent in both July and August. Thus, the compound seasonally adjusted annual rate for the third quarter of 2005 reached 9.4 percent.

To be sure, much of consumer-price inflation this year has been confined to the energy sector, whose prices have increased at a 122 percent annual rate over the first nine months. But the understandable fear is that energy-price inflation will eventually push up prices in other sectors, setting off a disastrous upward spiral. That would also require the Fed to react far more strongly than the “measured” pace it has followed so far in raising interest rates.

While the CPI measures the change in prices of goods and services purchased by households, the producer price index (PPI) for finished goods rose a very sizable 1.9 percent in September after climbing by 1 percent and 0.6 percent in July and August. September’s rise was the largest since January 1990, and the 12-month increase in the PPI (6.9 percent) is the highest in 15 years and more than double the rate (3.3 percent) for the 12-month period ending in September 2004.

Once again, soaring energy prices were the underlying force, rising more than 7 percent in September in the PPI’s finished-goods energy sector. During the third quarter, finished-goods prices have increased at an annual rate of nearly 15 percent, while the annualized prices for finished energy goods rose more than 80 percent last quarter. The monthly prices of so-called crude energy materials, which include natural gas and crude petroleum, increased 13 percent in July, 4 percent in August and 17 percent in September, bringing the annualized rate of increase for the third quarter to more than 250 percent.

Meanwhile,weekly earnings for 80 percent of the private-sector nonfarm workforce have not risen nearly as fast as consumer prices have increased. The inflation-adjusted weekly earnings of these production and nonsupervisory workers fell 1.2 percent last month alone — the steepest one-month decline since the early 1990s and the lowest level since George W. Bush became president.

Soaring energy prices and plummeting inflation-adjusted earnings explain why consumers feel so lousy. The University of Michigan recently reported that its Index of Consumer Sentiment plunged from 89.1 in August to 76.9 in September, while its Index of Consumer Expectations fell from 76.9 in August to 63.3 in September. Both monthly declines were the largest in a more than a dozen years, the Wall Street Journal reported.



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