Consumer prices register largest annual drop since 1950

It doesn't take a Harvard economist to deduce the following: there's little pricing power in the U.S. economy.

Consumer prices increased a minuscule 0.1 percent in May, the U.S. Labor Department announced Wednesday, as falling food prices slightly offset rising gasoline prices.

Further, the core rate -- which excludes the often-volatile food and energy component -- also rose just 0.1 percent. Economists surveyed by Bloomberg News had expected May consumer prices and the core rate to rise 0.1 percent. Consumer prices were flat in April and declined 0.1 percent in March.

Equally significant, consumer prices have now fallen 1.3 percent in the past 12 months – the largest decline in prices in the United States since 1950.

One caveat: almost all of the decline in the past year was due to falling energy prices, which have plunged about 27 percent in the past year, after the previous oil shock ended in 2008. However, oil and gasoline prices have risen substantially in the past six months. Even so, the lack of a decline in core prices suggests deflation is not taking hold.

At least at this juncture, inflation isn't taking hold either, despite record monetary and fiscal stimulus to liquefy credit markets and jump-start the U.S. economy from its worst recession in more than 25 years.

Further, wage pressure is not existent. Inflation-adjusted weekly wages (also called real wages) fell 0.3 percent in May, and have increased just 2.8 percent in the past year.

Little pricing power for companies

Most economists do not expect inflation to rise in the months ahead. They say the recession that has idled factory production and resulted in more than 5.5 million lay-off has led to excess capacity in the commercial sector and slack in the labor force that will limit price/wage increases. Credit Suisse Holdings Economist Jonathan Basile agrees.

"Any energy price increase is going to act as a tax on households in particular because their incomes are shrinking," Basile told Bloomberg News Wednesday. "It's difficult to raise prices."

Investors should pay attention to CPI data because it's the United States' most comprehensive and accurate measure of retail-level prices and costs. (The Producer Price Index measures wholesale prices and costs.) The U.S. Federal Reserve's dual goal is to maintain price stability while attaining full employment. If inflation reaches an unacceptable level – historically above three percent or where it becomes a factor in business decisions, the Fed will increase short-term interest rates to decrease demand and take pressure off prices and wages.

In May, energy prices increased 0.2 percent, gasoline prices climbed 3.1 percent, food prices fell 0.2 percent, fruit and vegetable prices declined one percent, meat prices dropped 0.9 percent, shelter costs increased 0.1 percent, medical costs rose 0.3 percent, prescription drugs added 0.6 percent, new car prices increased 0.5 percent, airfares declined 0.2 percent, and apparel prices decline 0.2 percent.

Economic Analysis: Once gain, back to your nest, inflation hawks. Inflation is non-existent, at least at this juncture of the Fed's and Congress' effort to re-liquefy credit markets and jump-start the U.S. economy. The U.S.'s pronounced recession has created price pressure – not pricing power – for businesses. Pricing power is so weak for firms that the U.S. Federal Reserve believes the nation is more likely to experience a bout of deflation – not inflation – at least through early 2010, and perhaps for a longer period. Fed policy makers will meet to discuss monetary policy and the direction of interest rates next week and the May CPI data will only reinforce the argument forward by the Fed's inflation doves that the nation can maintain an accommodationist monetary policy through Q4 2009/Q1 2010 to stimulate the U.S. economy and support the arrival of the recovery.
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