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Weekly Economic Commentary


Inflation and Factory Production Reports Present the Best of all Worlds, For Now

August 15, 2012

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The Consumer Price Index (CPI) held steady in July after a similar reading in June. From the main categories of the CPI, a decline in energy prices (-0.3%) offset mild increases in food prices (+0.1%) and the core CPI (+0.1%), which excludes food and energy to result in an unchanged overall CPI in July. Stepping back from recent history, the key is if the benign readings of the June-July period will prevail in the months ahead.

Chart 1 - 08 15 2012

First on the list is the fact that energy prices have risen in the early part of August, implying a reversal of the decline seen in July. Following close behind is the food price index, which is likely to reflect the impact of the drought in the near term. Wholesale food prices have recorded hefty increases in June (+0.5%) and July (+0.5%). Historically, there is a meaningful pass through of prices changes from wholesale to retail food prices with small delay. There is a strong positive correlation (72%) between the year-to-year change in wholesale food prices advanced two months and the year-to-year change in the food price index of the CPI (see Chart 2).

Chart 2 - 08 15 2012

The core CPI, which excludes food and energy, inched up 0.1% in July and puts the year-to-year increase at 2.1%, the smallest increase since October 2011. In July, price tags of hotel stays fell 3.0%, while that of rent (+0.3%) and owners’ equivalent rent (+0.2%) moved up. Prices of new and used cars declined in July as did airfares (-2.7%). The medical care price index (+0.4%) and apparel costs (+0.2%) rose in July.

Management of food and energy prices is outside the remit of the Fed’s monetary policy tool box. Higher food prices from a drought in the United States will raise headline readings of inflation in the months ahead. These developments will be part of the Fed’s discussion at the September FOMC meeting, with the decelerating trend of core CPI and the core personal expenditure price index (the Fed’s preferred measure of core inflation) providing the evidence of non-threatening underlying inflation readings.

Chart 3 - 08 15 2012

Table 1 - 08 15 2012

In other economic news, industrial production rose 0.6% in July, a sharp increase compared with the 0.1% gains of May and June. Positive contributions were reported for all major categories of industrial production – factory (+0.5% vs. +0.5% in June), utilities (+1.3% vs. -3.3% in June), mining (+1.2% vs. +0.5%).

Chart 4 - 08 15 2012

Factory production (the largest sub-component of total industrial production) in July was led by a 3.3% increase from the auto industry and included by noticeable gains in several other components – primary metals (+1.1%), computer and electronic products (+1.5%), aerospace and miscellaneous transportation (+1.7%). Factory production in July was dominated by autos and high-tech, with factory production excluding these two components posting only a 0.1% gain. The operating rate of the nation’s industries rose to 79.3% in July, which is gradually getting closer to the pre-recession highs.

Chart 5 - 08 15 2012

Table 2 - 08 15 2012

The main take away from the CPI and industrial production reports is that they do not tip the scale in favor of additional monetary policy support at the September FOMC meeting. But, the case for renewed policy support from the Fed is from the labor market and overall tepid performance of the economy. Market participants are awaiting Bernanke’s Jackson Hole speech at the end of the month for clues about the Fed’s stance.













The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.