Call it the Fed’s “oil dividend.” As the central bank’s inflation fighters meet Wednesday to set interest rates, they’ll get some major breathing room from the recent plunge in oil and gasoline prices.
That’s one reason that, after two years of steady rate increases, the Fed is expected to continue the “steady-as-she-goes” rate policy it adopted in August after two years of steady increases.
With oil prices down 20 percent since mid-July and pump prices down 15 percent and falling, fears have rapidly dissipated that high energy prices could touch off another 1970s-style round of inflation. If the recent drop in energy prices holds, Fed watchers say interest rates have likely peaked for now.
“It gives the Fed more reason to stand pat (on rates) beyond the September meeting into the meetings in the final three months of the year,” said Stuart Hoffman, chief economist at PNC Financial.
The government reported fresh evidence of slowing inflation Tuesday. Prices at the wholesale level edged up just 0.1 percent in August. The drop in gasoline helped offset a jump in food costs. And the "core" wholesale inflation rate — which excludes food and energy prices because they bounce around so much — fell by 0.4 percent after a 0.3 percent drop in July. A report last week showed that inflation at the consumer level was up just 0.2 percent in August.
In a separate report, the Commerce Department reported Tuesday that the housing market continues to slow down. Construction of new homes fell 6 percent in August, a much bigger decline than analysts had been expecting. Building permits hit their lowest level in nearly four years, a sign that the slowdown will continue in the months ahead.
Saving billions at the pump
With energy prices falling, consumers are getting immediate inflation relief at the pump. After peaking just over $3 a gallon in mid-July, gasoline prices have fallen to an average of about $2.60 as of last week — with further prices drops expected. In some parts of the country, pump prices have fallen back through the $2-a-gallon mark.
Energy analyst Peter Beutel estimates that consumers save about $3.8 million a day for every penny knocked off the price of a gallon of gasoline. That means consumers have saved billions of dollars from falling pump prices in the past month.
A sustained drop in energy prices could also take price pressure off airlines, shippers and other transportation companies that have been passing along their higher fuel costs to consumers.
The slowing housing market is also helping to cool inflation.
“With the housing sector now in a recession, with the inflation scare largely over, there's no reason at all for the Fed to raise rates,” Morgan Stanley chief economist Stephen Roach told CNBC Monday. “They’ll certainly stand pat and they'll continue to do that, and I think there's good chance they'll be talking about easing (rates) in early '07.”
That’s the view of about half the 22 Wall Street banks surveyed Monday by Dow Jones. Twenty of them expect the Federal Open Market Committee, which sets shorter-term rates, to hold rates steady at 5.25 percent at Wednesday’s meeting. Last month, the FOMC ended a two-year round of rate increases that raised the federal funds rate from a low of 1 percent. (The federal funds rate is the rate banks pay the Fed for short-term loans.)
But some economists say it’s too early to begin looking for rates to fall next year. In fact, a long-term drop in energy prices might even make it harder for the Fed to cut rates, according to Scott Brown, chief economist at Raymond James & Assoc.
“If gas prices continue down, consumer spending is likely to pick up even more,” he said. “And you have to ask: ‘Is the economy growing too fast where inflation pressures are likely to heat up again?’ ”
Higher energy prices have been just one of several factors pushing prices higher. After years of price-cutting made possible by lower manufacturing costs overseas, prices of imported goods have begun rising — thanks to a drop in the value of the dollar.
“Import prices were falling from 1995 to 2001 and early 2002,” said David Huether, chief economist at the National Association of Manufacturers. “When the dollar started coming down, within a quarter or so you saw prices of imports start to pick up. They’re not deflationary any more.”
Even if energy prices remain at lower levels – and that’s a big “if” – the folks at the Fed pay closest attention to the so-called “core” inflation rate - the statistic that excludes food and energy prices because they are subject to big, sudden ups and downs.
“(Core) inflation is already above the top of the Fed’s target,” said Hoffman. “Right now, they’re being patient. But it’s not like it’s been is at the lower end of the range and is starting to accelerate. It’s already gone through the presumed 2.0 to 2.5 percent threshold.”
