Prices Rise, and Interest Rates Sure to Follow

Article excerpt

It could be a summer of rising interest rates.

That's the sobering prospect for the US economy following news that the inflation rate is running at a quickening pace. Higher prices for such things as airline tickets, housing, healthcare - and of course, gasoline - are now starting to eat into consumer pocketbooks.

Wednesday, the Labor Department reported the May Consumer Price Index (CPI) rose 0.4 percent, after a 0.6 percent rise in April. This is well above the comfort level of the Federal Reserve, the nation's chief inflation-fighter.

The latest numbers just about guarantee the Fed will hike interest rates at the end of the month. Its new chairman, Ben Bernanke, an avowed inflation-fighter, may follow that with yet another increase in August.

The inflation pop, however, comes at a time when the economy may be starting to cool. This could keep the Fed from hitting the brakes too hard.

"The Fed is going to have to raise rates more out of a desire to keep the market from thinking the new sheriff in town is not serious about fighting inflation," says Anthony Chan, chief economist at JP Morgan Private Client Services in Columbus, Ohio. "Prices are rising against a backdrop of weakening housing and other parts of the economy."

Economists are most concerned that rising prices seem to have moved beyond the energy sector. Removing food and energy - typically the most volatile prices - from the inflation rate indicates that "core" prices in May rose 0.3 percent. Over the past three months, the core rate of inflation is up to an annual rate of 3.8 percent, the fastest pace in more than a decade.

"We're seeing a near-term acceleration in the core rate," says Gregory Miller, chief economist at Suntrust Banks in Atlanta. "An increase of half a percentage point at the next Fed meeting is a strong possibility before the Fed decides to back away."

However, Mr. Chan reports that such a large rate hike is not likely. In the past, Mr. Bernanke has said previously, the Fed has tended to "overshoot" by raising rates too high or dropping them too low. The central bank would then have to change directions, confusing the markets.

"I don't think Bernanke is going to put in a strong case for a half a percentage point increase," Chan says.

Though the inflation rate is accelerating, the economy has changed considerably since the last major period of inflation in the 1970s, Chan says. Back then, whenever the consumer price index rose, wages automatically ticked up via "cost of living adjustments." Most of those arrangements are now gone, he says, particularly at manufacturing facilities, like General Motors Corp., where total remuneration is being cut, not raised.

"A slowing economy will eventually lead to diminished pricing pressures," Chan says.

Until that happens, consumers are starting to feel the effects of rising prices on their pocketbooks. …