Inflation’s Great Divide

Goods prices have been dropping while services prices are on the rise—a gap that might only grow if the Federal Reserve raises rates

By Justin Lahart

The gap between inflation’s haves and have-nots is wide. All the Federal Reserve may be able to do is make it worse.

To judge from the price tags on stuff that gets sold in stores, much less the signs at gasoline stations, the U.S. is mired in deflation. But if it is services like renting a car or going to a show that one is paying for, inflation is very much on the scene.

It is a divide that has been on display in second-quarter results. Falling prices are one of the things that has been weighing on revenues at goods-producing companies. Among those in the S&P 500 that have reported so far, the median sales decline was 2.6%, according to FactSet.

The median service-sector company, on the other hand, experienced a 3.6% sales gain.

That divide was also on display in inflation figures the Commerce Department released Tuesday. Overall, consumer prices were up 0.9% in June from a year earlier, while core prices, which exclude food and energy prices to better capture inflation’s underlying trend, were up 1.6%. Prices for goods, however, were 1.8% below their year-earlier level, while services prices were up 2.2%.

Falling gasoline prices—regular averaged $2.37 a gallon in June versus $2.80 a year earlier—were only part of what drove the decline in goods prices. Prices for durable goods, which include long-lasting items like washing machines and bicycles, were down 2.2%. Much of the blame for the drop rests with weakness outside of the U.S., lowering imported good prices and forcing domestic competitors to follow suit. Given the gloomy global economic outlook, those price pressures will likely persist.

Services inflation, on the other hand, may heat up. Wages have been picking up, making it easier for service providers, which face little overseas competition, to raise prices. A fading drag from the Affordable Care Act on health-care prices should provide an additional boost.

When it comes to inflation, services, which account for two-thirds of consumer spending, carry more oomph—particularly when it comes to the core measure. So even if goods prices continue to cool, inflation may continue to drift close to the Fed’s 2% target. That would make policy makers at the central bank more comfortable with the prospect of raising rates before the year is up.

But the most immediate thing a Fed rate increase would likely do is breathe new life into the dollar, since it would boost the returns on U.S. fixed-income assets, drawing foreign investment. That, in turn, would push import costs, and goods prices lower. Services prices, largely insulated from the dollar, might not be nearly as affected.

The have-nots could end up having even less.

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