Inflation at 3-Year Low
Slower Economic Growth Kept Prices Under Control in 2006
Washington Post Staff Writers
Friday, January 19, 2007; Page D01
Inflation fell in 2006 to its lowest rate in three years, as tumbling fuel prices and a slowing economy cooled the pace of consumer price increases.
Other figures released yesterday showed unexpected signs of improvement in the housing market, adding to an overall picture of an economy that ended the year in relatively good health.
  Housing starts were up 4.5 percent in December, the government said. Analysts disagreed on whether the housing slump is ending. (By Gary Gardiner -- Bloomberg News) |
Low inflation is a critical component of the economy's health, allowing consumers and businesses to make financial decisions without worrying that their wages, savings or profits will be eroded by price increases. Inflation rose to worrisome levels in 2004 and 2005, leading to a series of interest-rate increases that helped send the housing market into a tailspin.
Ebbing inflation means that the Federal Reserve may avoid raising interest rates this year, holding them at levels likely to keep unemployment low and encourage economic growth.
Several analysts said, however, that inflation trends in recent years have mirrored swings in oil prices -- which have fallen lately but could go up again. The analysts also said the unusually warm weather last month might have encouraged more hiring, shopping and home construction, temporarily brightening the economic picture in December.
And though inflation has fallen, Federal Reserve policymakers think it remains too high. They expect the housing downturn to help keep economic growth moderate this year while keeping prices down.
Stock prices fell yesterday as many investors abandoned hope that the Fed might cut interest rates in the first half of the year to boost economic growth. Instead, the central bankers are considered virtually certain not to change rates at their meeting in two weeks, while declaring that they will raise them if inflation proves to be more stubborn than they expect.
The latest inflation numbers are "sufficient to encourage the Fed but not enough to enable the central bank to relax its guard against higher inflation," said Peter Kretzmer, a senior economist at Banc of America Securities.
Consumer prices rose 2.5 percent in 2006, largely reflecting rising costs for health care, food and rental housing, the Labor Department said. That pace was significantly lower than the 3.4 percent inflation of 2005, and was the smallest increase since 2003.
The annual change masked the volatility of fuel prices, which had surged in late 2005 after Hurricane Katrina and other storms. Oil prices rose through much of 2006 as well, peaking at more than $77 a barrel in July but then falling through the end of the year to about $63 a barrel. By December, fuel prices were 2.6 percent higher than a year earlier.
The department's consumer price index, a widely followed measure of inflation, rose 0.5 percent in December because of a sharp rebound in fuel prices that month.
Fuel prices caused inflation to outpace most workers' wage gains again last month. Average weekly earnings fell 0.1 percent in December from the month before, after adjusting for price increases, the Labor Department said in a separate report. But for the year, so-called real wages were up 2.1 percent. Those are the wages paid to non-managerial and manufacturing employees on private payrolls, who make up about 80 percent of the workforce.
Oil prices have fallen this month, which should dampen the January inflation figure. U.S. benchmark crude closed at $50.48 a barrel yesterday on the New York Mercantile Exchange.
Because oil prices can swing so much, economists and investors seek a sense of underlying inflation by studying so-called core measures that exclude food and fuel. The core consumer price index rose 0.2 percent in December, partly reflecting higher clothing and rental costs.
Core prices were up 2.6 percent for all of 2006 -- the most since 2001, the department said. But they fell to a 1.4 percent annual rate of increase in the last three months of the year.
In a separate report, the Census Bureau said builders broke ground on 4.5 percent more new homes in December than in November. And they obtained 5.5 percent more permits for future construction.
Those were surprising jumps, given that housing has been in the doldrums for months. Many analysts attributed the increases to warm weather in December, discounting the odds of a rebound in housing construction anytime soon. Many builders and investors are still struggling to unload bloated inventories of unsold homes.
Some observers disagreed. "Builders are not going to take on more construction loans, pay off contractors and put up new homes just because the weather has turned warmer," said Bernard Baumohl, managing director of the Economic Outlook Group. "Builders are motivated by one thing: the prospect that home buyers are seriously shopping again."
