Inflation is flat, market surges

Consumer prices held in May, damping fears of interest-rate boost

June 17, 1999|By William Patalon III | William Patalon III,SUN STAFF

U.S. consumer prices did not rise last month after an alarming jump in April, easing inflation fears and igniting stocks on hopes that the Federal Reserve won't have to raise interest rates more than once this year.

The Labor Department's Consumer Price Index report, released yesterday, said prices for consumer goods and services held steady last month after April's 0.7 percent increase, the CPI's biggest single-month gain in nine years. Economists had expected a 0.2 percent rise for May.

"I think the data is telling us that we can stow away our worst fears on inflation," said David Donabedian, portfolio manager for the Baltimore office of Pell, Rudman & Co., a Boston investment firm that manages $6.5 billion for clients. "It disavows the April numbers so that, while telling us the best news on inflation is behind us, it makes the case that we don't have a real inflation problem."

In response, the Dow Jones industrial average jumped nearly 189.96 points, or 1.79 percent, to close at 10,784.95. The Nasdaq Composite Index, composed mostly of technology stocks, rocketed 103.16 points, or 4.3 percent, its biggest-ever one-day gain.

The yield on the benchmark 30-year bond fell to 6.06 percent from 6.11 percent -- though it remained above the 6 percent level many analysts said spells trouble for stock prices.

Inflation is bad for stocks and bonds because it makes the future value of both types of securities unpredictable. Under current Federal Reserve Chairman Alan Greenspan and predecessor Paul A. Volcker -- both avowed inflation-fighters -- rising prices have been viewed as part of a ruinous upward spiral and need to be stamped out by raising interest rates. Higher rates, in turn, dampen economic growth, boosting mortgage rates, and often slashing corporate profits enough to spur layoffs. To fight particularly virulent inflation, the Fed has at times engineered recessions.

While yesterday's jump in stock prices signaled that investors were confident the Fed wouldn't push rates up too high this year, experts generally agreed that the central bank's Federal Open Market Committee would probably raise the key Fed Funds rate by a quarter percentage point, to 5 percent, when it meets June 29-30.

Thanks to yesterday's report, the spirit of that increase would be different than what might have been had consumer prices kept rising: from actually fighting inflation to a sort-of "insurance policy" move aimed chiefly at reassuring the financial markets that the inflation-fighting Fed remained on watch.

Through last month, the CPI increased at a 2.6 percent annual rate, up from 1.6 percent during the same period a year ago. The economy expanded at a blistering 4.1 percent pace in this year's first quarter, far exceeding the 2.5 percent rate the Fed has generally felt was sustainable without causing inflation.

"I guess the metaphor I [would use] is that the Fed will be tapping on the brakes," said J. Patrick Bradley, director of economic and investment research for Mercantile-Safe Deposit & Trust Co., an affiliate of Mercantile Bankshares Corp. "It's like you're on I-95 going past Bel Air and realize that you're going 75 miles per hour, so you tap on the brakes to get down to 65 or the Maryland State Police will get you."

Rate increase expected

A Bloomberg News survey of Wall Street's 29 biggest bond dealers found that 76 percent expected the Fed to raise rates later this month. Thirty-four percent expected the central bank to raise rates again when it meets Aug. 24. That's down from 52 percent a week ago.

Several economists interviewed by The Sun said they believed three rate increases are possible, with the last coming at the end of the year or early in 2000. That would counter three rate cuts the Fed made late last year to keep the "Asian contagion" from taking hold globally, said James Annable, chief economist for BankOne in Chicago.

Greenspan is scheduled to testify before Congress today about the state of the economy and could hint at what the Fed will do later this month.

Despite yesterday's euphoric stock-market reaction, real challenges remain for the Fed.

First, the benign CPI numbers aside, a spate of other reports released yesterday gave mixed signals about the potential for inflation in the U.S.

Unemployment is at a 29-year low, and labor shortages have been forcing companies to pay more to hire and keep good workers in different regions of the country and different business sectors. A separate Labor Department report said the average weekly earnings of a U.S. worker jumped 0.7 percent last month -- the biggest monthly increase in 16 years, though it followed two months of declines. Such wage increases areinflationary, since these worker/consumers have more money to spend. Theoretically, increased consumption means higher demand for products and services, which should translate into higher prices -- also inflationary.

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