INDICATOR: May Consumer Price Index/Weekly Unemployment Claims

KEY DATA: CPI: down 0.3 percent; Year-over-Year: 1.7 percent; Excluding Food and Energy: up 0.2 percent/Unemployment Claims: 386,000 (up 6,000)

IN A NUTSHELL: “Lower energy costs are keeping money in peoples’ pockets and they need that given the slowdown in the labor market.”

WHAT IT MEANS: Pressured consumers need a break and to some extent they are getting it from moderating retail costs.

The Consumer Price Index declined in May, largely as a result of huge drops in gasoline and natural gas prices. There was also some help on the food side as supermarket costs eased as well. Critically, the cost of fresh baked goods and cupcakes are coming down. Hallelujah! However, if you eat out, then you paid more.

However, most other areas posted modest to moderate increases. Medical services expenses were up and regardless of the decision on the health care bill, something has to be done if those costs are to be brought under control.

The current system is clearly broken. The financially-pressured consumer is buying used rather than new vehicles, driving up those prices. And apparel prices, which had been a key restraining factor for inflation, continue to jump. Surging airline and train costs caused transportation prices to rise as well.

As for the two usual suspects, education and cable, well those prices continue to rise as if there is not outside world. The so-called core index, which excludes food and energy, continues to rise at a pace that is higher than most on the Fed would like to see.

In a separate report, weekly unemployment claims continue to rise toward the magical 400,000 level. That is a rough cut point between job gains and losses. The claims numbers point to additional weak hiring reports and that does not bode well for income or economic growth.

MARKETS AND FED POLICY IMPLICATIONS: When the economy is strong and the growth outlook is positive, it is appropriate to worry about the direction of inflation. Right now, the modest expansion and the many hurdles facing the recovery make any concerns about consumer prices largely irrelevant.

But, there are those that believe the Fed has to take into account inflation trends so we do watch the data carefully. That said, with Mr. Bernanke switching attention to the headline number, which is rising at a less than target rate over the past year, it is hard to think that the current trend in inflation should lead to any change in Fed policy. The issue is not inflation it is growth and Europe is the key.

The Fed can only react to what is happening on the Continent, which once again shows how external factors can drive domestic economic activity.

The rise in unemployment claims, which stems from lowering hiring activities, is indicative of a business sector that does not know what will happen with both domestic policy and worldwide economic growth. It is hard to hire aggressively under those circumstances.