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Expect Hotter Inflation in Months Ahead

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

We got a lot of inflation data this week, including the Consumer Price Index. Inflation is a big piece of data on the radar of Morningstar's Bob Johnson; he is our director of economic analysis.

He is here to tell us what he saw in those reports today. Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: First question for you: We got CPI data on Thursday. CPI was up. What did you see in the report at the top level?

Johnson: The Consumer Price Index went up 0.5% this month from last month, so it's a relatively big number; if this happened 12 months in a row, we would be at 6% annualized inflation.

Stipp: So I know energy is one thing that a lot of consumers have noticed has been higher recently, and we have seen energy prices fluctuating, but generally, higher than they had been. To what extent, did energy itself contribute to that increase?

Johnson: Well, energy was a pretty hefty piece of the increase. Energy itself went up 4.6% in the month, and it's only relatively 10% of the index or so. So, it's not huge, but it did have a big effect on the number.

Stipp: But energy wasn't the only thing, obviously, you mentioned to me that it was more broad-based. So, what were you seeing on the upside that was contributing to that increase that we saw?

Johnson: There was a whole range of things that were up. Some of them are indeed tied to energy, and some of them are away from energy. Some of the things were up: Electricity was up, which had kind of been an offset to some of the things that had been happening in the gasoline complex for a while. Natural gas to heat your home was up, which had been down for many months and kind of kept a lid on things. So those two things, which had been keeping a lid on, kind of blew up this quarter a little bit, so that hurt the numbers.

Public transportation was up. We've talked many months about how any service provided by government, people are looking for new sources of revenue, and we're seeing increases there. Airlines were up over a 2%, so there was another area that was hit. Medical costs, which had been a couple of years ago really accelerating, and then really paused due to the recession, now come back again with a vengeance something like 0.4% in one month. So, those are some of the categories that have been up recently.

Stipp: On the other side of the coin, did anything go down or did anything keep the increase in check?

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Johnson: There were probably three things there that I'd look at. Apparel, which isn't a huge part of the index, but apparel was down almost 1%, so that was one thing. Restaurants, which have been a little bit slow this recovery. The price increases were only 0.2% versus the overall index, which was up 0.5%. So, that was one thing--again not a huge part of the number.

But shelter, which is a huge part of the number, and specifically the rent and rent-equivalent numbers were only up 0.1%. And that's over 25% of the index, so that really held it back; that's the good news in the report.

Stipp: So it seems that for a lot of the things that you just mentioned on the upside and on the downside, there is a bit of a trend in that, a lot of the things that went up are really not discretionary. So, fuel and things like public transit, people have to use those, food, things that people have to buy, whereas clothing and restaurants, maybe they are not up because it's more discretionary?

Johnson: I think there is some of that going on. I think if you have to spend it, you have to spend it, and that's what people are worried about--if you've got these necessities [going up] that you're going to spend less on the other, and that's going to make the price of the other things go down and while we saw some less on the upside, unfortunately we didn't see a lot go down.

Stipp: Okay. And I know that increasingly, especially as consumers are at the gas pump, they are more and more worried about inflation; they are seeing it in the grocery store, in the gas station. Is the Fed seeing the same thing? Because the Fed is also coming out and saying that inflation isn't that bad right now, that it's still in-check within their expectations.

Johnson: Well, you know the consumers are actually calling the Fed on that. Apparently there is a story going around that one of the Fed governors who was going out and giving a luncheon talk--it's something they are prone to do to try to explain their situation to the local towns and governments--and in one of these Town Hall type affairs, he said, "well inflation is not much of a problem," and one of the people in the audience raised their hand and said, "well, sir, have you been to the grocery store lately or filled the tank of your own car by chance?" And so there has been a real disconnect, and I think the Fed even Bernanke this week in his talks kind of states, "well, maybe there is a little bit of inflation out there, but we think it's temporary."

Stipp: So what is the difference in the experience of consumers and what they are actually seeing and how the Fed is calculating inflation? Why is there a bit of a disconnect there?

Johnson: Well, there is a lot of items that are up day-to-day--I mean the gasoline you are facing it, you see the price, and you know how much you put in your pump. My wife comes back and says I spent $53 at the pump this week; I know prices are up. It's something that mentally is in your mind. So, I think that's influencing people a lot. And the food prices are the same way.

Stipp: And the Fed is also looking at things more on a year-over-year basis, is that having a difference as well?

Johnson: Yes, absolutely. We are a little bit more tame on a year-over-year basis; the number is more just over 2% instead of if you annualize most recent months, which is closer to 6%.

Stipp: So, let's just turn the conversation and look forward a little bit. So, you mentioned to me that there was a consumer sentiment survey recently that had their expectations for inflation coming up, and then we also know what the Fed's expectations are. How are those two things lining up?

Johnson: Well, again, we're not always fans of consumer sentiment surveys, but the consumer thinks that inflation is going to run at a 4% to 5% rate in the year ahead.

Stipp: Which is really high compared to what we'd seen?

Johnson: That's really high, ... and even economists are thinking 2%, 2.5%, and even I am relatively high on inflation; I think it's going to be about 3%. So clearly, consumers are frightened, and there is good news and bad news about it. It may trim their spending a little bit, because they can't spend it on other things, but on the other hand, we've broken the deflation mentality that had the Fed so scared.

Stipp: So if consumers think that prices might go up in the future, they might try to find a way to make some of those purchases now instead of possibly paying a higher price for them in the months to come?

Johnson: Right. Instead of saying, "let's just wait until next month; this is definitely going to be cheaper then; I'll get it on sale.

Stipp: So, it's the opposite of that deflationary spiral that we had seen before. So, Bob, you mentioned that you were expecting around 3% inflation. What is the data telling you now about what we might anticipate in the months to come and looking forward about the actual level that we'll see?

Johnson: I think the next couple of months are still going to be rough. You had mentioned we got a lot of inflation reports this week, and we got the Producer Price Index, and that tends to lead the consumer; it doesn't all flow into the consumer. The businesses have to eat some of it, but the Producer Price Index was up well over 1%; it was way above expectations, and that may work its way through, and the other one that people watch a little less is that import prices were up again--well over 1%, well above expectations, and those import prices, those goods can go somewhere else. So, I don't think they necessarily have to reduce prices to get them to move, because they are going to sell them into another market. So, I get particularly worried when the import prices continue to go up at the pace that they are. So, I think we've got maybe a couple of months of these 0.4%-0.6% type of increases before we back off this summer.

Stipp: So it's very critical to keep an eye on this data that's going to be coming out. Thanks so much for joining me and for the insights today, Bob.

Johnson: Good to be here.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.