Economy rolls on with less worrying

Fed rate fears ease as latest data show inflation in check


The U.S. economy might be rocking and rolling, but inflation remains remarkably well behaved.

That was the main message from a fresh batch of government data on consumer prices, industrial activity and home building released yesterday. The new evidence further soothed investors who have been worrying that the Federal Reserve might raise short-term interest rates more than a quarter-point next week to slow the economy. Bond and stock prices rallied.

The Consumer Price Index -- a broad measure of inflation that reflects the prices of imports and services as well as those of domestically produced goods -- rose just three-tenths of a percent last month after registering no increase at all in May and June, in line with forecasts. Better still, most of the increase reflected higher energy costs -- which were widely expected and raised everything from gasoline prices to airline fares -- and another big increase in cigarette prices.

Best of all, the so-called core rate of inflation -- which excludes volatile food and energy -- was up only two-tenths of a percent last month despite the jump in transportation and tobacco prices. That core rate has been creeping up more slowly than at the same point last year, 1.7 percent compared with 2.4 percent.

"We knew energy was going to be up," said Cynthia Latta, an economist at Standard & Poor's DRI in Lexington, Mass. "There's nothing here that looks alarming."

At the same time, two highly cyclical sectors of the economy, manufacturing and housing, continued to expand briskly last month. Industrial production, which had been merely inching up earlier in the summer, grew 0.7 percent last month. While the nationwide heat wave accounted for heavy energy use and a bumper crop of air conditioners and fans, overall manufacturing output rose robustly, by 0.6 percent, despite a drop in car production. And construction of single-family homes and apartments, which cooled in June as mortgage rates climbed, rebounded sharply last month.

"What that's telling you is that even the interest-sensitive sectors aren't cooling off with higher rates," said Roseanne Cahn, chief equities economist at Credit Suisse First Boston. "The pickup in manufacturing is plenty strong, too."

The reports bolstered investor sentiment that the Fed will not raise the overnight bank lending rate, known as the federal funds target rate, more than a quarter of a percentage point. In the wake of a strong jobs report earlier this month, there had been speculation on Wall Street that the Fed might raise the rate by as much as a half-point. But a report on Friday showing a modest increase in prices at the wholesale level last month, combined with yesterday's figures, have eased those concerns. Even a quarter-point increase is no longer regarded as a sure thing.

"It's 50-50 whether there will be a tightening this month," said Latta. "If I had to put money on it, I guess I'd put my money on an October tightening. But it's such a close call."

At the moment, the inflation picture is one of crosscurrents. On the one hand, a number of the forces that clearly helped hold inflation down in the past are fading.

The slump in Japan and Europe, which drove down world prices for energy and other raw materials, seems to be over. The strong dollar, which made imports a bargain for Americans, has lately been weakening. The wholesale shift by employers to health maintenance organizations, which drastically slowed the rise in health care costs, is almost complete.

At the same time, as Alan Greenspan, the Federal Reserve chairman, has emphasized again and again, the U.S. labor market remains extraordinarily tight, with unemployment at a 30-year low and job growth strong.

Meanwhile, rapid productivity gains are holding down production costs and there is very little indication that strong demand is giving corporations much leeway to pass cost increases on to consumers via higher prices. While an earlier report by the National Association of Purchasing Managers showed that most manufacturers say they are paying higher prices, few report that they are receiving higher prices.

One exception, of course, is energy, which posted the biggest increase last month since last April, 2.1 percent.

As a result, transportation costs also rose. Gasoline prices jumped 4.3 percent last month, and air fares surged 6.5 percent. Another exception is tobacco prices, which surged 3.3 percent. The prices of imports -- about one-fifth of everything U.S. consumers buy -- also are going up.

But the prices of other goods are falling or rising more slowly than in recent months. Food was up just 0.2 percent last month. Housing costs, which account for nearly 40 percent of consumer outlays, rose just 0.1 percent last month, half the June rate. Medical care costs rose 0.3 percent, a bit more slowly than in June. Meanwhile, despite the predominance of imports, clothing prices continued to fall last month, dropping a hefty 0.9 percent.

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