Smith Faculty Opinion Article	May 17, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

Consumer Prices Jump in April
The Fed Likely to Keep Increasing Interest Rates

Today, the Labor Department reported that the Consumer Price Index rose 0.6 percent in April on a seasonally adjusted basis, as energy prices surged 3.9 percent. The consensus forecast was 0.5 percent, and my forecast published by Reuters was 0.8 percent.

Seasonally adjusted food prices were flat in April. This was in line with the 0.1 percent increase in April wholesale prices reported yesterday. From month to month, food prices often fluctuate, but inflationary pressures from food prices should be moderate through the summer.

Core producer prices producer prices less food and energy rose 0.3 percent in April. The consensus forecast and my forecast were 0.2 percent, as core inflation surged more than economists expected. The core rate was up 0.3 percent in March too.

Core inflation was up in both March and April, and this is a red flag for the Fed. The Fed is now more likely to raise interest rates again in June.

The producer price index data released yesterday indicates core inflation should moderate. Producer prices for nonenergy consumer goods increased only 0.1 percent in April but the CPI covers a broader range of consumer spending. In particular, the CPI includes medical services and education where inflation seems little constrained by market forces.

The outlook for inflation is significantly colored by energy prices.

Gasoline prices surged in April. The average retail price of gasoline in April was $2.79 per gallon, up from $2.47 in March. By May 15, it hit $2.99. Gas prices are likely to go higher through the spring and summer driving season, and significantly burden economic growth.

Diesel prices are surging too. Diesel prices rose from $2.56 per gallon in March to $2.73 in April, and reached $2.92 on May 15.

Productivity growth remains solid. Until recently, these gains have permitted producers of most final goods and services to absorb higher fuel prices and wage increases without pushing up consumer price inflation, and to enjoy strong profits. The recent moderation in nonenergy producer prices indicates those conditions persist and the recent surge in nonenergy consumer prices should subside.

Inflation, outside the energy sector, is likely to moderate, and the outlook for core consumer prices is guarded but remains favorable.

Overall the economic news is pulling the Fed policymakers in two directions. Core wholesale price inflation is under control, productivity growth remains robust, and a flagging housing market and moderating retail sales indicate the economy is cooling. However, core consumer prices surged in March and April, industrial production has been advancing smartly and capacity utilization is at its highest level since July 2000.

The May jobs and wage data could prove critical. April jobs growth was disappointing but wage increases were unusually strong. Both figures were likely aberrations, and the May figures should reflect a regression to the mean. However, if both jobs and wages increase significantly in May, the balance of data will tip in favor of another interest rate increase in June.

With the broader indexes of inflation driven higher by surging petroleum prices, the Fed will watch the jobs and labor cost data closely and want to make sure core inflation does not get out of control.

On the basis of the data we have to date, look for the Fed to push the Federal Funds rate to 5.25 percent in June.

Peter Morici is an economist and professor at the Robert H. Smith School of Business at the University of Maryland. He is a recognized expert on international economics, industrial policy and macroeconomics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission.