April 17, 2007 / 10:29 PM / in 11 years

Gas prices bite U.S. consumers, challenge Fed

By Joanne Morrison - Analysis

WASHINGTON (Reuters) - Soaring gasoline prices have cut deep into the wallets of U.S. consumers, posing another risk to growth and possibly more work later this year for the Federal Reserve as it tries to move inflation lower.

During the first quarter of this year, gasoline prices surged at a 34.5 percent annual rate, pushing overall energy costs up at a swift pace of 22.9 percent, the Labor Department said on Tuesday.

The jump in energy costs, which compares to a 2.9 percent increase for all of 2006, accounted for about 41 percent of the overall increase in the U.S. Consumer Price Index in the first three months of the year.

Economists say consumers are going to feel a pinch as the cost of gasoline, which is expected to increase as demand picks up during the heavy summer driving season in the United States, cuts into their spending power.

In addition, the price gains present a challenge to central bank officials, who want to ensure the underlying pace of inflation does not follow energy higher.

“I‘m skeptical that we will continue to see a moderation in core inflation,” said Conrad DeQuadros, an economist at Bear Stearns in New York.

New Mexico Sen. Pete Domenici, the senior Republican on the Senate Energy and Natural Resources Committee, said the gasoline price surge underscores the need for a national policy that includes more production and alternative energy sources.

“However, it is important that the Senate not pass legislation that will burden the American consumer with increased energy costs. Even slight, incremental increases in energy costs could result in inflation and have significant, adverse effects on the economy,” Domenici said in a statement.

The surge in gasoline prices comes at a time when many consumers can no longer count on rising home values to prop up their wealth and when credit spigots are drying up. And while stocks have held up, most Americans don’t stand to benefit.

Now, all they can rely on are wages, said Ken Mayland, president of ClearView Economics in Pepper Pike, Ohio.

“Consumer spending has held up really well, but there is less buffer for potential problems. We don’t have the added help from a buoyant housing market,” Mayland said.

LITTLE ELBOW ROOM FOR THE FED

In March, higher energy prices pushed the overall Consumer Price Index up 0.6 percent, the biggest monthly advance in nearly a year. But excluding volatile food and energy prices, the core CPI edged up only 0.1 percent. That was below economists’ forecast for a gain of 0.2 percent in core CPI in March, according to a Reuters poll.

While the lower-than-expected core CPI suggested the U.S. central bank may have scope to lower interest rates this year, the sharp gain in overall consumer prices puts the Fed in a tight spot as it seeks to strike a balance between its desire to see inflation move lower with the goal of wanting continued growth.

Economists say the Fed will have to watch energy and food prices more closely as there is a risk that cost increases in these areas could seep into the prices of other things.

“They are between a rock and a hard place,” said Peter Morici, a business professor at the University of Maryland.

U.S. refining capacity and gasoline stockpiles have been stretched thin by strong demand, U.S. environmental policies and pressures from export-driven growth and petroleum use in China, which have all combined to make global supplies more scarce, Morici said.

Soaring gasoline prices have shown no signs of easing this month. Last week they hit their highest level since August, Energy Department data showed.

Already, the current national average pump price is well above the government’s forecast summer average of $2.81 a gallon and the peak driving period is still to come. Some analysts expect gasoline to reach $4.00 a gallon by summer.

While financial markets still look for the Fed to lower borrowing costs late this year, some economists think prospects for a rate cut are growing dim.

The Fed has held interest rates steady since June and officials have said they are more concerned about inflation than slowing growth.

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