Prices rise, soar, stocks drop

Spike in the CPI leads to fears of inflation's return

Dow drops 194 on news

April increase of 0.7% is index's biggest since October 1990

May 15, 1999|By William Patalon III | William Patalon III,SUN STAFF

The "I" word -- inflation -- rejoined the American economic lexicon yesterday when a government report showed April prices for consumer products and services rose at their fastest rate in nine years, prompting stocks to plummet on fears the Federal Reserve might raise interest rates soon.

The Dow Jones industrial average dropped nearly 194 points, closing at just above 10,913. The yield on the benchmark 30-year Treasury bond jumped to 5.92 percent -- the highest level since a year ago today.

Yesterday's Labor Department report said consumer prices in April rose 0.7 percent, the biggest monthly increase since October 1990, and more than the 0.4 percent rise most had expected.

Excluding food and energy prices, which are more volatile than those for other goods and services, consumer prices rose 0.4 percent -- the biggest jump in four years and about double what was anticipated for that limited category.

In March, the Consumer Price Index, or CPI, rose 0.2 percent overall and 0.1 percent when food and energy prices were factored out.

April's rise pushed the annualized rate of inflation this year to 3.3 percent. That compares with a 1.6 percent rise for all of 1998, a year in which consumers benefited from falling energy prices.

"The best news on inflation is probably behind us," said Sung Won Sohn, an economist with Wells Fargo & Co. in Minneapolis. "Even though one month does not make a trend, I think we are beginning to see pent-up price pressure show up."

The CPI is the government's broadest measure of what consumers are paying for a basket of products and services and is one measure of the inflation level within the U.S. economy.

End to `disinflation'

"This marks the end of something: The one tremendous force that's driven the financial area -- particularly stock-market performance -- has been disinflation," said Richard Cripps, chief market strategist for Baltimore-based Legg Mason Wood Walker Inc.

Disinflation is a drop in overall price levels, which has buoyed consumers' enthusiasm to spend.

By contrast, inflation is a virulent rise in prices that makes it tougher to stretch a dollar. The Federal Reserve -- under Chairman Alan Greenspan and his predecessor, Paul Volcker -- has been a vigilant inflation fighter.

The Federal Open Market Committee (FOMC), the Fed's interest-rate policy group, has a regularly scheduled meeting Tuesday, but most experts said it's far too early for the Fed to ratchet up the overnight lending rate on loans.

Such a move would lead to higher interest rates on mortgages and consumer loans.

However, the FOMC could adopt a so-called "bias" toward raising the overnight rate, signaling the central bank's willingness to act if inflation accelerates.

Economists and market strategists differ greatly on whether yesterday's drop in stock and bond prices was an overreaction or, conversely, a signal that inflation has returned after a blissful hiatus as the economic expansion enters its ninth year.

`Short-term shock'

"I think this is largely a short-term shock," said Lacy Hunt, chief economist with Hoisington Investment Management Co. in Austin, Texas.

But, to William Gross, a bond manager with Pacific Investment Management Co. in Newport Beach, Calif., yesterday's consumer price report was "a warning shot" that Asia's long-awaited recovery and a continued strong U.S. economy can only serve to bring back inflation -- making the Fed more likely to strike.

A big piece of the jump in the CPI was attributable to a spike in oil prices, a situation many economists doubt will worsen.

Energy prices officially account for about a tenth of the index, and rose 6.1 percent last month, fueled partly by a 15-percent jump in prices at the gasoline pump -- the biggest one-month increase on record.

Food prices, which constitute nearly a fifth of the index, rose 0.1 percent in April after a 0.2 percent decrease in March.

Impact of fuel prices

Other increases included tobacco (3.6 percent), airline fares (2.0 percent), apparel (1.5 percent) and new vehicles (0.1 percent).

But even some of these have an energy-related component. Fuel is one of the biggest costs to an airline; some synthetic fabrics are petroleum-based; and the price of apparel includes the cost of shipping.

Several experts said a rise in the CPI would have to persist for several months to form a decisive conclusion that inflation had returned.

Besides, indicators can be contradictory.

First, though bond yields rose -- a reaction by investors that would seem to underscore a return of value-eroding inflation -- the dollar also rose, closing at a two-month high against the yen.

That puzzles Hoisington's Hunt. The reason: If inflation was on the rise, it would seem the dollar should fall, because the value of that dollar tomorrow, or next month, would be less than it is today -- meaning investors would want to get rid of dollars.

But a rise in a currency means more people want to hold it, signifying they believe it will keep its value or be worth more in the future.

Foreign investment

One could make another argument, that rising rates here are attracting foreign investors, who believe they can get a better return on their money in the United States than in their home markets -- particularly since Japan's economy still seems to be stalled.

To buy stocks or bonds here, these investors would have to convert their domestic currency into dollars. That demand could also drive up the dollar's value.

And though the much-ballyhooed "new era" of inflation-less growth might be gone, no one seems to be using the dreaded "R" word.

"It's not looking like a recession is anywhere on the horizon," said Bill Cheney, chief economist for John Hancock in Boston.

Wire services contributed to this article.

Pub Date: 5/15/99

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