- The Washington Times - Wednesday, June 14, 2006

Higher housing and energy costs drove inflation to a 5.7 percent rate in the past three months, the highest in a decade, sealing expectations yesterday that the Federal Reserve will raise interest rates further this summer and add to the costs weighing on consumers.

Yesterday’s consumer price report from the Labor Department raised red flags at the central bank, where officials express dismay at the underlying, or “core,” rate of inflation, which accelerated to 3.8 percent last month in the biggest increase since 1995. The core rate is dominated by housing costs and, though it excludes the skyrocketing gas and electricity costs consumers pay directly, it reflects moves by businesses to pass those costs on to consumers.

“That is just too corrosive to be accepted by a virtuous central banker,” the president of the Fed’s Dallas reserve bank, Richard Fisher, said in a speech in Texas. The Fed must be “relentlessly bird-dogging inflation to prevent a debasement of your dollars.”

The uptick in inflation this year has raised consumers’ expectations of price increases to 3.2 percent a year — a rate that would erode the purchasing power of a dollar to as little as 73 cents in a decade, he said.

“To me, this is more than discomforting. It is unacceptable,” he said, adding that the Fed should no longer adhere to its practice under former Chairman Alan Greenspan of mostly ignoring volatile spikes in energy and food prices. “People have to eat, drive and air-condition their homes,” he said.

The Fed’s redoubled attention to energy and housing-driven inflation, as measured by the Consumer Price Index, has heightened the importance and effect of inflation reports on the financial markets and economy. Yesterday’s bad inflation news was widely anticipated, however, and markets took it in stride, rallying after a series of tumbles in stock indexes around the world.

The Dow Jones Industrial Average yesterday added 111 points, recouping some of the 540-point loss it suffered in the past week since Fed Chairman Ben S. Bernanke inspired fears that the central bank would take the hammer to any increase in inflation. The move to 10,817 put the Dow back in positive territory for the year.

Some analysts say the Fed’s focus on housing and energy costs is ironic, and perhaps unwise, because the central bank has little control over either and its campaign to raise interest rates will add to the higher housing costs consumers have to bear.

About half of new home purchases in recent years were financed through adjustable-rate loans that will be adjusted sharply higher as a result of the Fed’s actions in the months ahead. Homeowners with fixed-rate mortgages do not face sharp increases unless they sell or refinance their homes.

Previous Fed moves to raise short-term rates by 4 percentage points since June 2004 already have contributed to a slowdown in the housing market and are pushing more people to rent rather than seek homeownership. The rush into rentals is driving up rent prices and is the principal force driving up the core rate of inflation, analysts say.

A critical component of the price index designed to track the cost of homeownership for the 69 percent of Americans who own homes actually measures what it would cost to rent the single-family homes they own. That rental index jumped by 0.6 percent last month, the most since 1990.

The Fed is in a “true dilemma” because “the origins of higher consumer prices are currently beyond their scope” and cannot be cured with higher rates, said Roger M. Kubarych, chief economist at HVB Group.

“Higher rates would speed up the slowdown of the housing boom and put further pressure on rents” and housing inflation, he said.

While Fed officials from Mr. Bernanke on down have left little doubt they are bent on raising rates, that is “no longer appropriate for the weakening economy,” Mr. Kubarych said. “Overdoing the tightening bears the risk of a recession — which ultimately would lower rents and [inflation] — a costly approach.”

Other analysts support the Fed’s war against inflation.

“The chairman has rediscovered his monetary manhood and is doing the right thing,” said Lawrence Kudlow of Kudlow & Co. “Price stability is the key to economic growth.”

President Bush expressed confidence that Mr. Bernanke and other Fed governors he appointed will get inflation under control.

“Obviously, the Fed is watching the signals for inflation very carefully,” he said at a press conference. “That’s Ben Bernanke’s job.”

Mickey Levy, chief economist at Bank of America Corp., said the Fed has little choice but to raise rates when faced with yesterday’s inflation numbers, which included a 35 percent leap in energy costs, 20.9 percent surge in transportation costs, 7.3 percent jump in clothing costs and 4.5 percent rise in health care costs over the past three months.

“It’s not that the Fed is losing its grip, but it will have to hike rates to maintain its inflation-fighting credibility,” he said. “I believe the Fed would like to pause, but I think a continued upward drift in core inflation numbers will not allow them to.”

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