Smith Faculty Opinion Article	December 18, 2006
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

No Change in Consumer Prices in November
Outlook Promising for Stock Prices

Today, the Labor Department reported that the Consumer Price Index did not change from October to November, on a seasonally adjusted basis, thanks to falling apparel, transportation, food, and energy prices.

Food prices were down 0.1 percent after rising 0.3 percent in September and October.

Energy prices fell 0.2 percent in November, after falling 7.0 percent in September. Gasoline prices fell 1.6 percent, fuel oil prices did not change, and natural gas and electricity prices rose 1.2 percent. Energy prices will likely move up in December.

Food and energy prices are quite erratic from month to month, and Federal Reserve policymakers pay close attention to movements in the core index. The Federal Reserve is particularly concerned with the pass through into other sectors of higher petroleum prices, which surged from March through August.

The core CPI, the CPI net of energy and food, did not change from October to November, and only rose 0.1 percent from September to October. The former figure was better than expected. The consensus forecast was 0.2 percent and my forecast published by Reuters, was 0.1 percent.

Since November 2005, core consumer prices have risen 2.6 percent, and the compound annual rate of change for the three months ending in November was 1.6 percent.

No Change Likely in Federal Reserve Interest Rate Policies

Core consumer price inflation is beginning to fall within Ben Bernanke's target range of one to two percent. However, two months of favorable news on core inflation are not enough to declare victory in the fight on inflation. More good news will be needed to convince hawks at the Federal Reserve that the inflation dragon is contained.

Inflation should continue to moderate in the months ahead. The wholesale price data released in recent months indicate Federal Reserve interest rate policies cannot much affect remaining inflationary pressures on consumer prices. Conditions in international oil, resource and grain markets will provide much of the further push on consumer prices.

Aggressive actions by OPEC, and shortages of U.S. refinery capacity, bio fuels strategies, prospective taxes on oil companies, and other regulatory constraints pose more immediate threats to price stability than the moderate recovery in U.S. growth expected by the first quarter of 2007.

In fact, if the new Congress should deliver on promises to tax oil companies or quickly tighten the business regulatory environment, inflationary pressures will crest, and the Federal Reserve would be severely constrained in its mission of accomplishing both price stability and growing employment and incomes.

Moderating economic growth, falling housing prices, and lower energy prices should relieve pressures on both the broader consumer price index and core consumer prices. Barring a crisis in energy markets, caused by a natural disaster or some other non-economic event, inflation should decline to comfortable levels in the first half of 2007.

With the housing and automobile sectors slowing, raising interest rates further would serve no useful purpose. The Federal Reserve should not change interest rate policy before its March meeting.

Outlook for Growth and Stock Prices

Growth should recover to about 2.5 by the first half of next year.

Home prices are moderating, not collapsing, and overall these have risen about 55 percent over the last five years. Recent adjustments in existing and new home prices should be viewed as healthy, reining in speculations in land values. Once completed, these adjustments should help establish the framework for price stability, and healthier growth less dependent on property speculation and borrowing.

Meanwhile, lower energy prices are cushioning the effects of the modest retreat in home prices on consumers, and homeowners still have considerable untapped equity.

November shopping did give retailers a bounce. Along with more robust commercial construction and business investment, a decent but not spectacular holiday should keep the economic expansion going, even if at a more moderate pace than in recent years.

Falling energy prices, moderating inflation and decent holiday sales further strengthen corporate profits and investor confidence. If the new Democratic majority in Congress does not spook the bond and equity markets with talk of aggressive new spending initiatives, taxes, or business regulations, the stock market rally remain robust into the New Year.

Household savings performance will improve, and ordinary investors should shift from buying bigger homes to buying stocks. Also, a lower dollar against the euro and other currencies is sparking interest in U.S. equities.

Moderate inflation, stronger company fundamentals, and stronger demand from ordinary investors and from abroad should push stocks higher in 2007.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.