August's 0.3% Inflation Rate Eases Deflation Risks

Consumer price inflation
Consumer price inflation

August's U.S. consumer price report, which contained an as-expected 0.3% price rise, will likely gladden the hearts of any economists and business executives who are looking for some sign of inflation. The reason? On a full-year basis, both the top-line and core price trends continue to reflect disinflation, or low inflation -- but not deflation.

Deflation, a protracted and systematic decline in prices, robs companies of revenue and can lead to the dreaded "deflationary spiral," in which price cuts lead to lower corporate revenue, prompting more layoffs and further consumer-spending declines, which prompt more price cuts, and so on. Deflation took hold hold during the Great Depression of the 1930s and made that economic disaster even worse.

August's core prices, which exclude the often-volatile food and energy component, were flat -- slightly lower than the 0.1% expected in the Bloomberg core inflation estimate -- but that's still not indicative of sustained, falling prices.

The same Bloomberg survey had shown economists expected consumer prices to increase 0.3% in August. Consumer prices rose 0.3% in July, after falling 0.1% and 0.2% in June and May, respectively.

Energy Prices Headed Up Again

Inflation over the past 12 months is running at a low 1.1% rate, a slight dip from the 12-month rate of 1.2% recorded in July. The core rate is running at a minuscule 0.9% pace, unchanged from July's 12-month rate -- which is about as low as the U.S. Federal Reserve wants core inflation to be on a full-year basis. Further declines in the core rate would likely signal that deflation has started.

So far, however, the price declines haven't been widespread. Prior to August, they were more a function of those volatile food and energy segments. But in August, energy prices turned up again, while shelter and apparel experienced downward price pressure. In August, gasoline prices surged 3.9%, and fuel oil rose 0.9%, with overall energy costs jumping 2.3%. Food prices rose 0.2%. Apparel prices fell 0.1% as many clothes stores cut prices amid sluggish back-to-school sales. Housing costs were unchanged in August, after rising 0.1% for three consecutive months.

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Also in August, used-car prices jumped 0.7% and are now up 15.5% in past 12 months because fewer new-car purchases meant fewer trade-ins, which reduced the supply of used cars available for sale, while Americans unable to afford new cars turned to used vehicles, increasing the demand for them.

Medical car prices rose 0.2% in August, furniture prices were unchanged, education costs were unchanged and recreation prices fell 0.2%.

August's consumer price report provides further evidence that the U.S. economy is still avoiding dreaded deflation. Although uncontrollable events -- a hurricane in the Gulf of Mexico that shuts down oil refineries or some geopolitical event that disrupts the flow of oil from the Middle East -- could cause oil prices to surge higher and trigger oil-shock inflation, current supply/demand conditions point to continued low inflation for the U.S. economy for at least the second half of 2010 and probably for longer.

Interest Rates Can Stay Low

Labor force slack will likely keep wage increases contained, and a U.S. industrial sector still operating well below capacity means manufacturers won't be able to increase prices at will.

Mild inflation means the Fed will be able to maintain its ultralow interest rate policy through at least the end of 2010 to help stimulate the economy and lower the nation's high 9.6% unemployment rate. The price environment is about where the Fed wants it to be: low inflation, but with little sign of deflation taking hold.