What’s behind the recent rise in inflation

By June 15, 2006Economy

Business is UpFollowing an 0.4% rise in March and 0.6% up tick in April, the Labor Department reported yesterday that the Consumer Price Index (CPI) rose strongly again by 0.4% in May. While the recent increase in the CPI has been fueled by surging energy prices, even the “core” CPI, which excludes food and energy products, has accelerated recently. Specifically the “core” has risen by 0.3% in each of the past 3 months (the first time this has happened in over a decade.)

Since February, the core CPI has risen at an annual rate of 3.8 percent. Again, this is the fastest pace in a decade. However, this rise in the core CPI is more a function of a slowing housing market than anything else.

The main driver of the acceleration in the core CPI has been housing, specifically an increase in owners’ equivalent rent (OER), which accounts for more than a quarter of the weight of the core CPI and is designed to measure changes in the cost of housing through the rental market. As the housing market has slowed, demand for rental units has increased, and so have rental prices, which have, in turn, pushed up OER prices. Over the past 3 months, the OER prices have risen at an annual rate of 5.6%, the fastest pace since the early 1990s.

However, excluding housing, the core CPI remains relatively well contained, growing at a 2.8 percent pace during the 3 months ending in May, with core goods prices up by less than 2 percent.

All told, the May report on the CPI shows that while energy and housing prices have risen significantly in recent months, pass through to other segments of the economy remains modest. With the economy showing significant signs of slowing, the Federal Reserve would be well advised move into a holding pattern and leave interest rates alone at its meeting at the end of the month.

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