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No Stop Sign Yet: Inflation Revs Up
Fed Watchers Backpedal After CPI's March Surge

By Nell Henderson
Washington Post Staff Writer
Thursday, April 20, 2006

Climbing gasoline prices helped push inflation higher last month, the government reported yesterday, heightening concerns that businesses may be passing more of their energy costs to consumers.

The Labor Department's consumer price index, a widely followed inflation gauge, rose 0.4 percent in March after edging up a mild 0.1 percent the month before. The report caused analysts to reconsider predictions that the Federal Reserve will soon stop raising interest rates to keep inflation under control.

Much of the March increase in the CPI reflected a 3.6 percent jump in gasoline prices.

Gasoline prices have continued to climb this month. The national average price of a gallon of regular was $2.80 yesterday, up from $2.51 a month ago, according to the AAA auto club. Oil prices have risen as well, trading above $72 a barrel yesterday and settling at a record high for the third straight day.

Prices also rose broadly last month for items such as food, housing, clothing, medical care, recreation, transportation, education and communication.

The core CPI, which excludes food and energy prices, rose 0.3 percent in March, its fastest pace in a year, suggesting that more businesses are boosting prices to cover their higher costs of moving goods, paying electricity bills, and heating their stores and offices.

The inflation report signaled "that the long-awaited pass-through of higher costs to a wide range of consumer prices has arrived," wrote Kenneth Beauchemin, an economist at Global Insight Inc., a financial analysis firm.

Stocks rallied Tuesday after a summary of the central bank's last policymaking meeting in March showed that Fed officials believed that they were nearly done raising interest rates, in large part because inflation was so tame. Higher rates make it harder for consumers and businesses to borrow and spend, which slows growth and tamps down inflationary pressures.

Most members of the policymaking Federal Open Market Committee "thought that the end of the tightening process was likely to be near" at the March 27-28 meeting, according to minutes of the session.

Many analysts and investors concluded from the minutes that the Fed would raise its benchmark federal funds rate, the overnight interest rate charged between banks, just one more time, to 5 percent from 4.75 percent at the next FOMC meeting in May, for a 16th consecutive increase since June 2004.

But the committee's March statement was based on the observation that core inflation "was not in the process of moving higher," the minutes said. Indeed, "some meeting participants expressed surprise at how little of the previous rise in energy prices appeared to have passed through into core inflation measures."

FOMC members also said then that they remained concerned that high energy prices might fan core inflation higher. And they emphasized that their decision on when to stop raising interest rates would depend on whether economic growth slows and inflationary pressures ease sufficiently in coming months.

"What a difference a day makes," wrote economists at PNC Financial Services Group, commenting on the shift in financial market sentiment from delight over the Fed minutes to disappointment with the CPI report. "Any further pressures on the core CPI could lead to a more aggressive FOMC."

If the March inflation surge turns out to be a one-month spike, and if the softening housing market continues to cool growth, Fed officials probably will raise the benchmark rate to 5 percent in May and then leave the rate unchanged at the next meeting in June.

That is possible if it turns out that the March figures largely reflect one-time changes such as higher prices for new spring clothes, increases in hotel rates and air fares at the start of the spring travel season, or a single price adjustment to make up for heating and lighting costs that have crept up over the past year.

But if businesses find that strong economic growth empowers them to keep raising prices in coming months, and if core inflation stays high, the Fed would raise the benchmark rate again in June and perhaps after that.

Fed officials also would keep lifting the rate if they saw that consumers and investors were starting to expect higher inflation, which makes it easier for firms to raise prices.

Energy prices rose 1.3 percent last month and are up 17.3 percent over the 12 months that ended in March, the Labor Department said.

Rising energy prices leave consumers with less cash to spend on other items, which might also slow spending and help cool the economy.

Consumer prices rose faster than wages for most workers in March, the Labor Department said in another report. After adjusting for inflation, average weekly earnings fell 0.3 percent last month.

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