Bloomberg
May 9, 2005

Labor costs are in check, but is that a little inflation smoke coming from consumer prices?

NEW YORK (CNN/Money) — One of the big themes this year in financial markets for policymakers and for investment advisors will be inflation: is it really coming back and how much will interest rates be pushed up by the Federal Reserve to make sure it doesn't?

May 9 (Bloomberg) — Bloated inventories and high energy prices will cause the recent slowdown in economic growth to linger into the second quarter as businesses and consumers curb spending, a Bloomberg News survey of economists found.

The economy may grow at a 3.2 percent annual pace from April through June after expanding 3.1 percent the previous three months, based on the median forecast of 64 economists polled from April 29 to May 6. The estimate fell a half-point since April, marking the deepest reduction in a quarterly forecast since the monthly survey began two years ago.

Inventories swelled last quarter as businesses and consumers curtailed spending amid surging fuel prices, suggesting companies will need to trim stockpiles this quarter, economists said. The Labor Department's report last week showing payrolls and incomes jumped in April eased concern that growth in the second half of the year would also suffer.

"We saw a huge buildup of inventories in the first quarter and some of that appears to be unintentional because of slower sales," said Lynn Reaser, chief economist at Banc of America Capital Management in Boston. The unemployment report "suggests that the slower pace of growth we expect this quarter is unlikely to spill over into the second half of the year. The economy should regain traction relatively soon."

Reaser trimmed her growth forecast for this quarter to 3.1 percent from 3.9 percent.

Inventories Expand
Inventories rose at an $80.2 billion annual rate last quarter, the most in almost five years, a report last month from the Commerce Department showed. The 3.1 percent increase in gross domestic product last quarter was the smallest in two years. The department is forecast to report later today that wholesale inventories probably rose 0.7 percent in March after a 0.6 percent increase in February.

Estimates for third quarter growth held at 3.5 percent and those for the last three months of the year slipped a tenth of a percentage point compared with last month to 3.4 percent, the monthly survey showed.

Projections of slower growth this quarter pulled the full- year 2005 GDP estimate down to 3.4 percent from 3.8 percent, the biggest reduction for a yearly forecast since the survey began two years ago.

"The small business market is certainly very challenging right now," Michael Alter, president of SurePayroll.com, a Skokie, Illinois-based provider of payroll services whose clients employ about 10 employees or less, said in a May 6 interview. "What you have is an environment in which prices are flat and all of your costs, most of your costs, are rising."

Jobs Report
About two-thirds of the survey responses arrived before the Labor Department reported May 6 that employers created 274,000 jobs in April, 100,000 more than the median forecast. Some economists tempered their expectations for slower growth as a result.

"We are having an internal discussion and it's possible we may have pulled down our second-quarter estimate too much," said Nariman Behravesh, chief economist at Global Insight Inc. of Lexington, Massachusetts, who pegged second-quarter GDP at 3.1 percent before the employment report, compared with a 3.8 percent estimate last month.

"We are seeing the economy beginning a gradual deceleration, but the slowdown is probably a little less pronounced than we thought a few weeks ago," Behravesh said. Global Insight may boost the forecast for this quarter by "a couple of tenths" based on the pace of hiring, he said.

Consumer spending this quarter will probably grow at a 3.1 percent annual pace, according to the survey median. The gain would be the smallest in a year and matches last month's forecast.

Gasoline Prices
"Rising gasoline prices should pare back consumer spending," said Christopher Rupkey, a senior financial economist at Bank of Tokyo-Mitsubishi Ltd. in New York. "The growth slowdown forecast stands despite these big jobs numbers." Rupkey cut his estimate for growth this quarter to 3.2 percent from 3.6 percent.

The average price for a gallon of gasoline at the pump rose to a record $2.32 in the second week of April, according to Energy Department figures. The price dropped to $2.28 for the weekend ended May 2 and crude oil prices have fallen to about $51 a barrel from $58.28 on April 4, the highest in more than two decades of futures trading.

Persistently high fuel costs also boosted inflation expectations, the monthly survey showed. Consumer prices will probably rise 2.7 percent this year compared with a 2.5 percent increase projected last month, the survey showed. Prices rose 3.3 percent in 2004, the most in four years.

Faster inflation will probably keep Federal Reserve policy makers raising the target interest rate in coming months, the survey showed. The rate will reach 4 percent by yearend, 1 percentage point higher than the current rate, according to the survey median. The forecast matched last month's estimates.

"Inflation is getting a boost from energy," said Rupkey. "The Fed is worried about inflation pressures, and so are the forecasters."

The forecast for the benchmark 10-year Treasury note fell to 4.5 percent for this quarter from 4.7 percent in the previous survey. The rate was 4.26 percent as of May 6. The fourth-quarter forecast remained at 5 percent.

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