Inflation at 40 year lows, deflation now a ‘worry’ but is this really the case?

So often analysts look first to inflation when warning of the pitfalls of spikes in lending rates and premature celebration of a bounce back economically. Based on the most recent data the US should exhale and see that inflation won’t hamper a recovery and in fact earnings could afford to increase via inflation in this very unique market. The US is at a once in a generation crossroads as inflation has reached its lowest point in almost 50 years, in real terms deflation is now of moderate concern which will cut hiring and confidence we are told. Consumer prices fell in April for the first time in 14 months though its worth noting that consumer spending was sluggish also. While many future decisions may hinge on that inflation rate, its not really as low as we’re being told – more on that later in the article.

A sharp reduction in energy prices of 1.4% led the downturn with the balance carried by natural gas. I recall about 6 weeks ago when gas plummeted some $0.30 per gallon in a week locally and even saw ‘panic buying’ – well the opposite but you know what I mean and assumed this would have a domino effect. Those same prices have falled another $0.05-$0.10 per gallon in subsequent weeks which provides inflation just the anchor it needs to stay in check. Food prices climbed a modest 0.2% as most goods were flat or dropped marginally over the same period of time. The key (core) inflation rate for the 12 month cycle was just 0.9% which according to data is the lowest rate since the early 1960’s. The majority opinion holds that this trend sees no likely upswing in the short term which in turn will alleviate any pressure to raise interest rates any time soon. Earlier concern that federal stimulus funds may cause a spike in inflation have proven to be inaccurate. Deflation is entering the vocabulary for the first time in generations as a soft economy coupled with low demand is forcing many goods to be sold at lower rates just to keep inventory moving. The US economy is on a very thin ledge as deflation would cause many worried analysts to predict that the recovery has not only stalled but shifting into reverse. How accurate is that assessment though, the graph below makes me wonder.

Inflation data 2009/10 courtesy Mandel on Innovation & Growth

I don’t share the view that this presents any significant risk, although we are seeing historic lows for inflation it is worth noting the very small asterisk – inflation data is tied to products and goods, and indeed those numbers are very low. However, what isn’t widely reported is that the inflation rate for services has risen and not only just recently. The inflation rate for services has now been increasing for 11 consecutive months, from a recession low of 0.0% the climb has been gradual but very consistent to a current level of 2.5%. Not alarmingly high but if the 2010 trend continues (which is just might) a 4.0% rate is more than possible by the end of the year. These figures are key as spending for services remains intact with the same uniform levels as overall consumer spending. If service providers are charging 3 or 4% more for their provision than they were a year ago then consumer spending automatically has risen, in turn this will fuel wage improvements and some expansion. Not to mention the fact that service providers primarily are growing in capacity as the economy moves ever further away from a manufacturing base. When you think of service sector jobs consider services as healthcare, finance,  city workers, police, legal, accounting, management consulting,  webdesign and marketing, call centres, recruiters, fundraising, mailhouse services, entertainment and advertising. Do you know plenty of people who work in those fields? Compare that with those you know who work in manufacturing and then ask yourself which inflation measurement should be addressed first?

Don’t let the core inflation rate be the benchmark for how the economy is performing, the vultures might not share all of the data but it is there to be reviewed.