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Inflation mounting, but where is the Fed?

Posted: Friday, April 23, 2004

NEW YORK (AP) Federal Reserve officials keep talking about how inflation isn't a threat. But if you're buying a cup of coffee or shopping for new clothes, you might see things differently.

Prices for most goods and services aren't going through the roof by any means. Still, new data suggests that the outlook for inflation in changing, with more prices going up across more sectors.

It sounds like it is time for the Fed to face up to the issue and start saying how it would fight inflation.

''The seeds for inflation have been sown,'' said Gary Thayer, chief economist at the St. Louis investment firm A.G. Edwards & Sons Inc. ''The Fed can't be perpetually patient in dealing with this.''

For most of the last year, the Fed's attention has been on the risks associated with prices falling too quickly, also known as deflation. When that sets in, it has the potential to derail the pace of the economic recovery.

To prevent that from happening, the Fed has tried to give the economy a push by keeping short-term interest rates at lows not seen in 45 years. Given the way prices have been rising lately, that plan may now be working too well.

The Consumer Price Index, the government's most closely watched inflation gauge, rose by 0.5 percent last month, well above what most economists had expected. More dramatic is the CPI's annualized gain of 5.1 percent over the last three months, compared with an increase of 1.9 percent for all of last year.

Excluding energy and food costs, ''core'' consumer prices rose by 0.4 in March, the biggest increase since November 2001. What was surprising was what fueled that gain: largely a surge in prices of clothing and hotel lodging, both of which have been sluggish for some time.

Other indicators also point to higher inflation, like the sharp price increases for a wide range of commodities ranging from beef to gold to steel. Gas prices have climbed more than 30 cents this year. Even milk prices are heading up.

Given those gains, businesses are starting to pass along their higher costs to consumers. For instance, paper-product makers including Kimberly-Clark and Georgia Pacific are boosting the price of such things as toilet paper, tissues and paper towels, while Folgers will start charging more for coffee.

A recent survey from the National Federation of Independent Business found that 19 percent of its member firms from a wide range of industries including manufacturing, retail, finance, insurance and real estate reported an increase in their average selling price in March, the biggest gains since June 2000.

But even with all that going on, the Fed has been largely mum on inflation.

All it said after its March meeting of its Federal Open Market Committee was that inflation risks were ''almost equal'' to deflation risks. And in recent weeks, some Fed governors have been downplaying the onset of inflation.

At least for now, the Fed may feel there is nothing to worry about. Inflation is trending at a tame 1 percent to 2 percent, just enough to keep the economy's engines going by giving businesses some pricing power back, and the lack of wage pressures and tightness in the labor market could prevent prices from surging out of control.

But the Fed can't brush off mounting inflationary pressures for too long without hurting its credibility.

''Most market participants believe that Fed officials are behind the curve, thinking that inflation will overshoot, potentially significantly, the FOMC's implicit inflation objectives,'' William Dudley, chief U.S. economist at Goldman Sachs & Co., said in a recent report to clients.

Since inflation can be driven by expectations, Dudley points out, Fed officials may have to let Wall Street know soon that it is aware of the problem and what it plans to do about it that is, raise interest rates.

Federal Reserve Chairman Alan Greenspan will have his chance to give some hints on this when he testifies before Congress later this week. The Fed could also alter its statement after its May policy meeting.

Whatever is said or isn't will be closely watched.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org



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