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Johnson: Inflation No Major Cause for Concern Today

Robert Johnson, CFA
Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With rising prices at the grocery store and also at the gas pump, many consumers are beginning to become worried about inflation. I'm here today with Bob Johnson--he's our director of economic analysis--to take a look at what's happening with inflation and if there really is cause for concern. Bob, thanks for joining me today.

Bob Johnson: Great to be here today.

Glaser: So what is the current state of inflation data today? Just how much are price levels rising?

Johnson: Overall, the inflation rate has ticked up a little bit year-over-year, which is the best way to look at it. It's up about 2.1% this June compared with June a year ago. The 60-year average on that number is about 4.1%. The median is more like 3.1%. So, we're certainly below what the normal metrics are, but we're quite a bit above where we last October or November when we got down to inflation rates of about 1% year over year. So, we've ticked back up again.

Glaser: So, what's driving that increase?

Johnson: It's very interesting what has happened, especially with the recent data. We've talked again and again about the droughts in Texas and California and Brazil driving up different food products. Now the drought has broken in some places, but it takes a long time for food to wind through the food chain. It starts with corn and soybeans--the basic feedstock--and you get chicken prices coming down first because of their short lifecycle. [It takes] closer to a year with pork [prices] and almost two years with beef. So, clearly we've had some better news on the drought, but it's going to take a while to entirely work through the system. That said, the food prices were the best part of the June report. They're only up 0.1% after being up 0.4% or 0.5% a couple of months in a row. Food is an important part of the index, and it's the highly visible one. The consumer feels bad when he has to pay a lot more for a steak or a pound of bacon or a quart of milk. It's visible. Also, the price of gas. Those make people feel uncomfortable even though they aren't necessarily a huge portion of the CPI [Consumer Price Index] number.

Glaser: How about gas then?

Johnson: Gas was a very interesting number in this survey. It was probably the biggest negative in the report. On a month-to-month basis, [the index] was up 0.3%. Gasoline was up 0.15% or half of the monthly increase. But the odd thing is that gas prices didn't go up at all at the pump. It was the old seasonal-adjustment factor again. Prices usually come down in June, and so they do their seasonal-adjustment factor. So, even though prices were exactly flat month to month, when they added in the seasonal-adjustment factor, it looked like prices were up 3.3%. If you take that at a 5% weight, that's how you get to 0.15%, which is a pretty healthy number. So, that was the biggest negative in the report. Another big negative in the report was that [drug prices] were up big again. They were up 0.5% in May and 0.7% in June. After a really quiet year in 2013--no price inflation in drugs--they are really on a tear this year.

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Glaser: We're at a little bit over 2% year-over-year inflation growth--about what the Fed has been targeting. At what point do you start to get worried that inflation is really going to take a hit on economic growth?

Johnson: Mechanically, the record shows that when you get to about 4% inflation--that's the number that really starts to drive the economy back into a recession. We're a long way from that. I don't think we're there yet in the numbers that I'm seeing.

Glaser: What could get us there then? What factors would drive inflation higher than where it is today?

Johnson: There are four factors that really drive inflation. Only one of them is the problem, and that's commodities right now. We've talked about that with the droughts and the geopolitical situation pushing up energy prices. That's the one of the four that might be problematic, but those types of inflation-driven situations usually don't last long. People change their uses and move around. So, it's not as big of an affect. The second one would be fiscal policy, which remains very tight. Fiscal spending, even before you adjust for inflation, is only up about 1% this year. That's certainly tight. Money supply is at around 7%, which is what it has been for the last two or three years. That's not a big number compared with historical averages. So, I'm not worried about that number. The output gap remains near 5%--a very wide gap. It's hard to have inflation going through the roof when you've got such low capacity utilization.

Glaser: What's your forecast for inflation for the full year then?

Johnson: For the full year, I'm a little higher than I was at the beginning of the year, but I'm at 1.8% to 2% for the overall year. I feel a little better about that forecast after seeing the June report that showed a few items down. Automobiles were down, for example, which was a bit of a surprise in June.

Glaser: No major cause for concern though?

Johnson: I'm not worried about inflation right now. I think it's obviously one of the biggest things you have to keep your eye on, but right now I feel very good about the number.

Glaser: Bob, thanks so much for your thoughts today.

Johnson: Thanks.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.