Inflation Watch

June Highlights:

• The drop off in oil prices coupled with the decline in prices of many consumer staples brought the headline CPI down in May by 0.3 percent. Consumer prices remain 1.7 percent higher than one year ago.
• For producers, prices followed a similar pattern; they were down 1 percent in May and up 0.7 percent from May 1 year ago.
• Core consumer prices (those excluding food and energy) are just outside the bound of the target range of 1 to 2 percent. Core producer prices are also experiencing higher growth than headline prices.
• In part because prices are still close to the target range, the Fed has committed to continue the low-rate policy to late 2014 as noted in the January statement.
• While slower price growth in headline measures will help the Fed keep its policy commitment, pressure from rising core prices which include services like rents, hospitals, and education may eventually push the Fed to raise rates before many analysts expect them to.
• The following tables summarize key figures while the graphs show increasing and decreasing prices for a few items.

Why Inflation Matters for Housing

Inflation (price-level growth) is important for REALTORS® because it can lead to shifts in interest rate policy by the Federal Open Market Committee (FOMC). Generally, the FOMC lowers interest rates to stimulate the economy. However, rates that are too low may lead to inflation. To combat inflation, the central bank increases interest rates but this policy may dampen economic growth. For example, recently, the FOMC committed to keeping rates low through 2013 to help shore up economic activity, but this commitment comes with its own set of risks.

During the recent financial crisis, fears of deflation (price-level decline) were rampant. (Deflation caused a downward spiral of prices that destroyed the economy in the Great Depression.) With financial markets now stable, some fear that inflation is around the corner. Stagflation, another unpleasant economic condition characterized by high unemployment and high inflation, is also a possibility. In stagflation, it is difficult for the central bank to raise interest rates to combat inflation due fear of further job market deterioration if demand is hurt by the increased interest rates.