Tags: Economy

Inflation: The High Cost of a Steadily Improving Economy

Thursday, 17 February 2011 07:12 AM EST

Steady improvement in the economy may soon come at a price — faster inflation.

Shoes, clothes, tires, plastics and other products all cost more at the wholesale level last month, putting pressure on businesses to pass the increases along to their customers.

The hikes also give ammunition to critics who fear that the Federal Reserve's bold steps to strengthen the economy have started to feed inflation and need to be reined in. Those critics include some Fed officials.

A widely watched measure of wholesale inflation, the core Producer Price Index, rose 0.5 percent last month, the largest monthly increase since October 2008. The entire index, which includes volatile gas and food prices, rose 0.8 percent.

Drug prices rose 1.4 percent, the most in almost three years. Prices rose for products throughout the economy.

Abercrombie & Fitch Co., which sells clothes primarily marketed to teenagers, said it expects to raise prices later this year because of soaring costs for raw materials, particularly cotton.

Those costs "are the biggest headwind we face," CEO Mike Jeffries told investors Wednesday. "We're comfortable that we can pass some of these increases on to the customer. We're not comfortable with how much."

The maker of Hanes underwear and T-shirts raised prices in February and may do it again this summer. And food companies like Kraft Foods and McDonald's have said in recent weeks that they will raise prices this year, too.

Stores are reluctant to pass along the higher costs at a time when their customers are already dealing with high unemployment and paychecks that aren't getting much bigger. So far, inflation at the retail level remains tame.

But some economists fear that inflation could become troublesome later. New notes released Wednesday show Fed officials last month raised the prospect of scaling back the Fed's $600 billion program to help the economy by buying government bonds.

The bond-buying program is supposed to help by lowering interest rates on bonds, which can drive down interest rates for other types of debt, like mortgages and loans. But flooding the economy with new money can also ignite inflation.

Still, Fed officials decided at last month's meeting to maintain the program, concluding that inflation was not yet a problem and that the economy was not improving fast enough to put a major dent in unemployment.

Through most of last year, the Fed worried more that the weak economy might spur deflation — a prolonged drop in prices and wages, which can make people unwilling to spend. In response, the Fed acted to strengthen the economy and raise inflation slightly. Low inflation is generally consistent with a healthy economy.

"It's too early to panic about inflation," argues Nigel Gault, chief U.S. economist at IHS Global Insight. "There won't be an inflationary spiral unless wage inflation picks up."

Gault says wages are not likely to rise quickly anytime soon. High unemployment means employers aren't under much pressure to pay their workers more.

Companies are having to pay more for their raw materials because commodity prices have risen, mostly because of rising demand from fast-growing developing economies and bad harvests in many countries.

The cost of cotton, for example, has doubled in the past year. The price of corn has doubled in just six months.

By the end of this year, consumer prices could be rising at an annual pace of more than 2 percent, says Carl Riccadonna, an economist at Deutsche Bank Securities. That would be twice as fast as a year ago.

In a separate report, the Fed said factories produced more goods in January for the fifth straight month, partly because of better demand for new cars and trucks.

Overall industrial production fell for the first time in a year and a half, though. It had peaked in December because utilities were cranking out power to keep people warm during the brutal winter. Utility output then dipped in January.

In another report, the government said home construction rose at the fastest rate in a year and eight months. There was a spike in apartment building, but construction of single-family homes declined, a sign of further weakness in the housing market.

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Steady improvement in the economy may soon come at a price faster inflation.Shoes, clothes, tires, plastics and other products all cost more at the wholesale level last month, putting pressure on businesses to pass the increases along to their customers.The hikes also...
Thursday, 17 February 2011 07:12 AM
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