Sunday, January 4, 2004

Price mystery baffles analysts

New data revive deflation concern

By Rachel Beck
The Associated Press

NEW YORK - No sooner did the Federal Reserve seemingly back away from its worries over deflation than new economic data revealed that core consumer prices fell this fall for the first time in 21 years.

That's making it all the more tricky to figure out where prices are heading next - and which direction they go matters because prices are sure to have a big influence on the Fed's next move with interest rates.

An upturn in prices could mean rates will rise soon, while signs of falling or stable prices could keep them low for some time.

Confused yet? Don't worry, even economic experts are baffled.

Since World War II, the Fed has largely tried to keep inflation in check. But deflationary concerns took center stage starting last spring after the Fed said the probability of dropping prices exceeded that of rising prices.

When a destructive deflationary cycle takes hold, consumers stop spending because they think even better deals are on the way. Then businesses make deep price cuts to attract customers, and that eats away at profits.

The good news is we haven't gotten stuck in such a mess - at least yet. And recent comments from the Fed indicate that its central bankers believe the threat may be over.

After its December policy-making committee meeting where it left a key short-term interest rate at a 45-year low of 1 percent, the Fed issued a statement that said the prospect of inflation going lower had diminished and was now about equal with the possibility that inflation could increase.

Certain sectors of the economy are already experiencing inflation. Look at the steep gains in commodity prices, with the Commodity Research Bureau's spot index soaring 16 percent over the last year, while gold prices have surged above $400 for the first time since the mid-1990s. Medical care and education services are also sharply higher.

The weak dollar could also be inflationary. Non-oil import prices are now rising modestly, climbing 1.1 percent in November compared with a year earlier, when they had dropped slightly. And OPEC said earlier this month that it may cut production to protect itself from the falling dollar, which could boost oil prices.

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