Inflation remains quiet, keeping pressure off the Fed

The nation's inflation rate remains frozen in place – at practically the lowest level in forty years – at a time when the economy as a whole is thawing out quickly.

Economists believe this low inflation rate – at about a 2.5 percent annual pace – should help keep the Federal Reserve from raising short-term interest rates at least through the rest of the spring.

This week, the bank said it had moved from concern about the recession to a "neutral" position on the economy.

The nation's central bank is not likely to get worked up over yesterday's consumer price index (CPI) numbers, which show that inflation rose 0.2 percent in February after a similar increase in January. The so-called "core rate" of inflation – without the more volatile food and energy components – rose 0.3 percent.

"Inflation still looks pretty tame," says Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh. "Inflation is steady at a low pace."

The modest inflation rate has been giving consumers a real increase in incomes.

Last year, paychecks rose a little more than 4 percent. Consumers, with money in their pockets, helped to keep the recession very mild, says Robert Gay, head of fixed-income research at Commerzbank Securities in New York.

But Mr. Gay says the Fed is concerned this windfall may not continue, which may slow the economic recovery.

For example, last year energy prices fell. The result, in effect, was like a tax cut, giving consumers more money to spend. This year, as the US economy bounces back from recession, energy prices are starting to edge back up.

The uneven nature of the recovery was reflected in another report yesterday. The Conference Board, a business group based in New York, reported that its index of leading economic indicators was unchanged in February after rising for four consecutive months recently.

The index is intended to be a gauge of economic activity some months in the future.

The Conference Board cited weak corporate profits and slack export demand as some of the factors that may dampen the pace of recovery.

Some economists believe the report is evidence the economy will go through a "double-dip," that is a slowing in mid-year before picking up again later.

Despite yesterday's inflation news, there is also considerable debate on Wall Street over the future direction of inflation, says Mark Zandi of TheEconomy.com, an economic website. Some economists worry that as the Fed policies make money more freely available, inflation could become a problem later this year.

The bond market has already begun to reflect some of those concerns, with long-term interest rates rising over the past two weeks.

Yet other economists believe inflation will remain relatively dormant as long as the dollar remains strong and the labor market is unsettled.

A strong dollar makes it easier to import goods, which keep domestic producers from raising prices. The soft job market makes it harder for unions to get wage increases.

"My overall sense is that inflation will push higher, driven by higher energy costs, but the core rate – reflecting the weak job market ... – will drop in the months ahead before rising next year," says Mr. Zandi.

Stan Shipley, an economist at Merrill Lynch & Co, agrees that price pressure will stay low for now.

"Historically, inflation falls in the first year of an expansion," he says . That's because low labor costs and excess capacity at factories bring down inflation for goods, Mr. Shipley says. The service sector follows.