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Energy Fuels Fears of Broader Inflation

Oil costs are hitting a range of businesses. As some pass increases to customers, economists worry that prices will spiral upward.

October 06, 2005|Bill Sing | Times Staff Writer

Rising energy costs are causing Americans to pay more for such diverse products as cat litter and express delivery services, sparking concerns that protracted inflation might be returning as a primary threat to the U.S. economy for the first time in more than a decade.

Signs of higher inflation are beginning to multiply across the economy. Clorox Co. said this week that it would boost prices on almost half its products, on top of increases already announced for its food containers, trash bags and liquid bleach.

FedEx Corp. said that starting next month customers would have to pay higher fees to have their packages shipped.

The National Assn. of Manufacturers said Monday that many of its members were facing higher energy prices. Those could eventually be passed to customers.

The prospect of mounting inflation is pressuring the Federal Reserve to keep raising interest rates, which in turn could make consumers pay more for home mortgages and other loans.

Warnings from several Fed officials about rising inflation helped spark a broad sell-off in the stock market this week, as many investors appeared to lose hope that the central bank might soon pause its rate-hiking program.

The Dow Jones industrial average tumbled 123.75 points Wednesday to 10,317.36, its lowest level in three months.

Inflation at the consumer level this year is running at a 3.9% annualized rate, the highest since it reached 6.1% in 1990 -- when there also was a major surge in energy prices.

A business trade group report Wednesday said that a gauge of prices paid by services companies -- including firms in agriculture, legal services, utilities and construction -- climbed last month to its highest level since the group's survey began in 1997, adding to concern that fuel costs are feeding inflation.

Many economists still are estimating relatively low inflation next year -- in the 2% to 3% range, as measured by the consumer price index.

But energy prices, including natural gas, are expected to remain elevated at least for the remainder of the year, offering little relief to businesses and consumers.

If that happens, overall inflation could end up well above forecasts. Allen Sinai, head of Decision Economics Inc. in New York, said energy prices could lift the overall inflation rate to 4% next year. Although that would be a far cry from the double-digit inflation of the late 1970s, it could spook investors and consumers who have been used to low inflation for most of the last 14 years, he said.

Some economists fear that consumers and businesses might begin to assume that worsening inflation is inevitable. That could lead to even more price hikes, starting an inflationary spiral similar to that of the 1970s that could eventually throttle consumer spending and stifle economic growth.

"Some time has passed since price inflation last flared up in the U.S. economy," said John Lonski, chief economist at Moody's Investors Service in New York. For now, he said, consumers are absorbing broadening price increases, but "how consumers will respond to a protracted advance by final product prices is unknown."

Other experts, however, think recent inflation threats may be overblown and will subside as the effects of hurricanes Katrina and Rita wear off.

Prices for crude oil and gasoline have fallen from their post-Katrina peaks, amid evidence that consumers are scaling back driving and curbing purchases of gas-guzzling vehicles.

But Fed officials in recent weeks have continued to warn about the inflation threat, boosting expectations that they will continue to tighten credit. Many analysts now expect the Fed to raise its benchmark short-term interest rate to at least 4.5% by early next year, up from 3.75% now and 1% in June 2004.

Indeed, to maintain investor confidence amid growing inflationary pressures, the Fed has no choice but to continue boosting rates, some analysts say.

"Many years have passed since investors last doubted the Fed's ability to control inflation," Lonski said.

The risk is that the Fed might overshoot and lift rates high enough to trigger an economic slowdown or recession. Virtually all postwar recessions -- including the last one in 2001 -- were preceded by Fed rate hikes.

Rising energy prices have yet to result in significant job losses or cutbacks in business spending outside of the auto and airline industries, Lonski said. That's because today's rising inflation is largely a function of strong demand in a growing global economy, not because of oil embargos or energy shortages as was the case in the 1970s.

The specter of higher inflation comes in sharp contrast to 2001, when the primary worry of Fed Chairman Alan Greenspan and other central bank policymakers was not inflation but its polar opposite: deflation.

Officials then were concerned that falling prices and other financial maladies afflicting Japan could spread to the United States and elsewhere.

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