The U.S. economy is expanding without creating inflation, government reports showed, encouraging Federal Reserve policy makers to stick to their course of gradual interest-rate increases.
Prices paid by consumers unexpectedly fell 0.1 percent last month, the first decline in almost a year, led by a drop in energy prices, the Labor Department said today in Washington. Industrial production rose 0.4 percent, twice as much as expected, according to a report from the Fed.
Factory production increased in May at the fastest pace since October, according to today's figures, and energy prices rose since last month. Fed Governor Donald Kohn today said that the Fed's policy is "still accommodative" and low long-term interest rates pose a risk to the economy, suggesting the central bank will keep raising its target rate.
The yield on the benchmark 10-year Treasury rose to the highest since May 17.
Core consumer prices, which are less volatile because they exclude energy and food, rose 0.1 percent in May after no change a month earlier. So far this year, consumer prices are rising at a 3.7 percent annual rate compared with a 5 percent increase at the same time last year. Core prices are rising at a 2.4 percent annual pace, down from a 2.5 percent rate in the first five months of 2004.
Market Reaction
Economists predicted no change in the consumer price index, according to the median estimate of 69 economists surveyed by Bloomberg. The core rate was forecast to rise 0.2 percent.
The yield on the benchmark 10-year Treasury note rose to 4.12 percent at 10:33 a.m. in New York from 4.11 percent yesterday. A report from the U.S. Treasury today showed foreigners bought less U.S. debt in April than in the previous two months.
The Fed is forecast to raise its benchmark overnight bank lending rate for a ninth straight time since June 2004 at the end of this month, based on the median forecast in a Bloomberg News survey of economists.
Kohn told a conference in New York today that "policy is still accommodative, and we still anticipate removing that accommodation at a measured pace." Fed Chairman Alan Greenspan made similar comments to Congress last week.
Some economists said central bankers may be closer to ending their string of interest-rate increases.
Industrial Production
"The economy has absorbed a surge of prices, mostly energy related, and things are simmering down," Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. The decline in prices may "cause the Fed to think it's reaching a neutral interest-rate level and reaching the point where it can move to the sidelines," said Mayland, who correctly forecast the drop in the consumer prices.
Work at factories, which accounts for almost 90 percent of industrial production, rose 0.6 percent in May, the Fed's report showed. A slowdown in the growth of inventories after a first- quarter acceleration may be bolstering production. The Commerce Department said today that inventories in April rose 0.3 percent, the smallest rise this year.
Empire State
Manufacturing is improving this month as well, a separate report from the Fed showed. An index of New York state manufacturing rose to 11.7 this month from minus 11.1 in May, the Fed Bank of New York said. The 22.7-point increase was biggest since May 2003.
"We saw this one coming because our order backlog has been increasing," said Harry Volande, chief financial officer of Siemens Energy & Automation Inc., a subsidiary of Munich-based Siemens AG. "Industrial production will remain strong through the end of the calendar year. Confidence among business leaders is pretty good right now."
Business investment is picking up again after a surge in 2004, when tax advantages siphoned orders away from earlier this year. Production of consumer goods rose 0.5 percent in May, the Fed's report showed.
Workers' earnings adjusted for inflation rose 0.3 percent last month after a 0.1 percent drop in April, the Labor Department said in a separate release. The May increase was the biggest since September of last year and suggests consumers have more spending power.
"We're increasingly confident about the health of the consumer," said Brad Anderson, chief executive officer at Best Buy Co., in an interview yesterday. "The consumer has weathered a lot of challenges and held up very well." The "consumer is solidly there in the marketplace and we don't see any dissipation of that." Richfield, Minnesota-based Best Buy is the No. 1 U.S. electronics retailer.
Prices
The core consumer inflation rate was held down by a surprisingly large drop in hotel-room rates, according to economists such as David Greenlaw, chief U.S. fixed income economist at Morgan Stanley in New York. Excluding the 2.4 percent drop in lodging away from home, the core would have been up 0.3 percent, Greenlaw said.
Energy prices fell 2 percent in May after rising 4.5 percent a month earlier, the Labor Department's report showed. Gasoline prices dropped 4.4 percent and natural gas costs fell 0.2 percent.
The cost of all goods including cars, apparel and food fell 0.4 percent last month after rising 0.9 percent in April. Goods prices have risen 2.4 percent since May 2004. New car prices rose 0.1 percent last month after decreasing 0.1 percent in April and the cost of clothing was unchanged after declining 0.6 percent the month before.
Greenspan
The consumer price index is the government's broadest gauge of costs for goods and services. Almost 60 percent of the CPI covers prices consumers pay for services, ranging from medical visits to airline fares and movie tickets. Service prices rose 0.1 percent last month and are up 3.1 percent over the last year.
"We are finding little evidence of inflationary pressures on the product side," Greenspan told the Joint Economic Committee of Congress last week. "There is some evidence, as I mentioned in my prepared remarks, that a passing through of costs has been easier. But in any event, overall inflation at this stage does remain modest."
The cost of medical care rose 0.3 percent last month after a 0.2 percent increase in April. Airfares rose 2.2 percent last month after rising 3.6 percent in April.
Housing costs, which include some energy costs and account for one-third of the index, rose 0.1 percent after rising 0.3 percent. A category designed to track rental prices rose 0.2 percent.
--With reporting from Andy Burt and Carlos Torres in Washington, Jeannine Defoe and Fred Fishkin in New York, Lynne Marek in Chicago and Mary Schlangenstein in Dallas. Editor: Golle
To contact the reporter on this story: Bob Willis in Washington (202) 624-1837 or bwillisbloomberg.net.
To contact the editor responsible for this story: Kevin Miller at (1) (202) 624-1914 or kmillerbloomberg.net.
-0- Jun/15/2005 15:12 GMT
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