NEW YORK — February producer prices came in weaker than expected dropping 0.6 percent in the month. Expectations had been for a decline but by a more moderate 0.2 percent, said Paul Ferley, assistant chief economist with RBC Economics Research.
On a year-over-year basis, prices are still rising by a sizeable 4.4 percent although this is down from the 4.6 percent recorded in January 2010. Much of this upward pressure on an annual basis reflects the effect of energy prices, which are up 16.6 percent on an annual basis in February despite a monthly decline of 2.9 percent.
“Going into the producer price report, expectations had been for a drop in prices although by a more moderate 0.2 percent,” said Ferley. “The anticipated decline was premised on indications of weakness in gasoline prices, yet the actual 7.4 percent drop reported this morning retraced a greater than expected share of the 11.5 percent rise in January. This morning’s report also showed a sizeable 5.6 percent monthly drop in heating oil. These declines helped to offset another 0.4 percent rise in food prices that matched the gain in January.”
Eliminating the effect of the volatile food and energy components, core prices rose an expected 0.1 percent in the month down from a 0.3 percent rise in January. The minimal gain in the core component occurred despite a marked 0.5 percent rise in passenger car prices that retraced an equal-sized drop in January. This increase was tempered by modest 0.1 percent price declines in capital equipment, tobacco products and light trucks. An even greater decline in the light-truck component had been expected given the 1.9 percent surge recorded in January.
On a year-over-year basis, core prices are up only 1.0 percent, which was unchanged from both the January rate and the average rate of increase over the previous-four months.
“The negligible rise in core prices after the outsized 0.3 percent gain in January will provide reassurance that inflation pressures, at the producer level, are not building up in the system,” said Ferley. “This reinforces the view that the slack built up over the course of the recession, and evidenced by a still-high rate of unemployment, is keeping inflation pressures contained. This will allow any tightening in policy to be in a large part determined by how quickly the unused capacity is being absorbed.
“Given our forecast of modest, near-term growth and limited downward pressure on the unemployment rate, the tightening in policy is expected to be gradual,” said Ferley. “Fed funds is only projected to start rising from its current range of 0 percent to 0.25 percent by the fourth quarter of 2010 and is expected to finish the year at a still very accommodative 0.75 percent.”
U.S. Fed makes only minor changes to its characterization of the economy implying no imminent shift in the direction of policy
The statement issued by the Fed at the conclusion of Tuesday’s policy-setting FOMC meeting was very much in line with expectations and flags no imminent shift in policy, said Ferley.
It suggested a very modest upgrade to its characterization of economic growth; however, this did not alter the assessment that inflation “is likely to be subdued for some time.”
As a result, the central bank indicated that the Fed funds would remain in its current target range of 0 percent to 0.25 percent “for an extended period.”
Fed President Hoenig dissented once again to this phrase, as he did in January, arguing that it was no longer warranted and “could lead to the buildup of financial imbalances.”
The slight upgrade to the characterization of the economy was conveyed in a number of revisions to the text from January, said Ferley.
For example, the Fed suggested that “the labor market is stabilizing” in contrast to the comment that the deterioration is abating. As well, business spending on equipment and software was characterized as rising significantly as opposed to the characterization in January that it appeared to be picking up, Ferley explained. In contrast, however, housing starts were characterized as “flat at depressed levels” following no mention of residential investment in January, he noted.
“The remainder of the statement provided updates on the winding down of the central bank’s other initiatives to provide stimulus to the economy,” said Ferley. The MBS and agency debt purchase programs were characterized as “nearing completion” with the remaining transactions to be completed by the end of March. In terms of the various liquidity facilities opened up during the height of the crisis, the central bank indicated that it has been in a large part closed down ‘in light of improved functioning of financial markets.’
“Today’s statement represents a slightly more upbeat assessment of the growth outlook, although there was nothing significant enough to alter a still benign characterization of inflation,” said Ferley. “As the growth outlook continues to improve, policy will at some point need to be tightened via higher interest rates although no such move appears to be imminent.
“The only near-term nod toward greater restraint is the comment that asset purchases will for the most part be complete by the end of this month,” he added. “There was no indication when the central bank may start to shrink the size in its balance sheet by the eventual selling of these assets. Our current forecast assumes that any hikes to the Fed funds are not likely until the end of this year.”
SOURCE: RBC Economics Research press release