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FED FOCUS-Fed view that deflation risk easing helped by CPI data

WASHINGTON, May 15 (Reuters) - U.S. consumer prices are falling at the fastest pace in over 50 years but “core” prices appear to have stabilized, backing the Federal Reserve’s view that the risk of deflation is easing.

The stability in core prices, which strip out food and energy costs, has eased fears of a Japan-style deflation in which a broad range of prices fall, undercutting economic growth.

At the same time, growing excess capacity in the U.S. economy suggests inflation is not about to come roaring back, so the Fed may have until well into next year before it has to begin tightening monetary policy.

“We are certainly not at the point where you have to worry about inflation,” said Nigel Gault, economist at IHS Global Insight in Lexington, Massachusetts.

Gault said the danger of a pernicious downward spiral in prices of the kind that hobbled Japan for a decade was clearly not suggested by the latest U.S. inflation figures on Friday, although the danger of deflation could not be dismissed while the economy was still fragile.

The government said on Friday that consumer prices declined by 0.7 percent year-over-year in April, the largest 12-month drop since 1955. But a collapse in gasoline prices was a big reason for the fall. In contrast, core inflation edged up by 1.9 percent for the year.

“There are certainly signals in the latest data that are comforting to anyone worried about deflation,” said Dean Maki, joint chief U.S. economist at Barclays Capital in New York.

“Some of the categories that were extremely weak are less weak,” he said, citing firmer prices for used vehicles, lodging away from home, and medical costs as reassuring signals the U.S. recession was not fueling a widespread downward price spiral.

Such a deflation crushed Japanese demand during the 1990s as consumers delayed spending in the hope prices would fall further, while borrowers defaulted on loans that had been taken out to purchase assets like property that had also lost value.

Fear that the global economic crisis was pushing the United States in the same direction as Japan in the 1990s has savaged financial markets in the past year with U.S. stocks hitting a 12-year low in March. The U.S. recession has lasted for 17 months so far and is now the longest since the Great Depression.


The U.S. recession of 2008 was sparked by a collapse in the housing market but recent signs that house sales are picking up and house price falls may be slowing have encouraged hope the recession is easing its grip and that economic growth will return in the second half of 2009.

Fed Chairman Ben Bernanke said on Monday that he believed the risks of deflation were receding, although it was still a threat that the U.S. central bank had to take seriously.

While the latest numbers support his verdict, falling energy prices are likely to continue to drag headline inflation measures down.

Mike Englund, chief economist for Action Economics in Boulder, Colorado, think the change in consumers prices will trough at minus 2.3 percent year-over-year in July.

But he says this won’t distract policy-makers.

“The restrained but upward trajectory for most U.S. prices in 2009 is welcome at the (Fed), as they walk the line between the risk of near-term deflation but longer-term inflation,” Englund said.

The tough task for the Fed officials will be knowing when to start tightening monetary policy, since unemployment will probably still be climbing when the proper moment arrives.

“The real trick for Bernanke’s legacy will be his exit strategy ... They don’t sound a bell at the bottom of the cycle and if they wait until it is obvious it will clearly be too late,” said Englund.

Bernanke, speaking on Monday at a conference hosted by the Federal Reserve Bank of Atlanta on Jekyll Island, Georgia, said the Fed faced a dilemma but was not on unfamiliar ground.

“I think in a very deep sense the problem that we face is really no different from the one central bankers always face once the economy comes out of a downturn and begins to recover,” he said.

“We have to, on the one hand, be aggressive, to achieve the necessary support for the economy which has taken a very hard blow from the financial crisis, to allow it to recover to avoid any risk of deflation which I now believe is receding but certainly needs not to be ignored.”

“But at the same time to be nimble enough to remove stimulus in a way that will allow us to assure price stability in the medium term,” he said. (Reporting by Alister Bull)