The New York Times
Tuesday 26 February 2008
Two worrisome trends for the economy - falling house prices and the rising cost of everything else - picked up speed in data reported on Tuesday, putting policy makers in an increasingly tough position.
If they move too aggressively to cut interest rates and stimulate the economy, they might stoke inflation at a time when consumers are already squeezed by higher prices for food, energy, clothing and other goods. But if they choose more austere measures, the economy may weaken substantially faster.
"The Fed is now having to walk a very fine line," said Jane Caron, chief economic strategist at Dwight Asset Management, an investment firm that specializes in bonds. "We have clearly seen an acceleration in inflation pressure in the last couple of months and the risk is that the markets are going to react negatively to aggressive easing going forward." Not surprisingly, a measure of consumer confidence fell to its lowest level in nearly five years. But the stock market was up slightly in midday trading after falling modestly at the open. Energy and technology stocks led the market higher after oil prices surged above $100 again and I.B.M. announced that it would buy back an additional $15 billion of its stock and improved its profit forecast. Treasuries moved slightly higher, indicating that bond investors were not overly fearful of inflation.
Tuesday's data provided fresh evidence of the housing market's prolonged slump. A leading index of home prices in 20 cities fell by 9.1 percent in December from the same month a year ago. Using a three-month moving average, the index, the Standard & Poor's Case-Shiller, is falling at an annual pace of more than 20 percent. The index tracks repeat sales of single-family homes; it does not include condominiums.
Another government index of home prices that covers more of the country but does not include loans above $417,000 fell 1.3 percent in the fourth quarter, after falling 0.3 percent in the third quarter. The index, compiled by the Office of Federal Housing Enterprise Oversight, showed prices declining in all states, except Maine.
The Labor Department reported that wholesale prices, which exclude taxes and distribution costs, rose 1 percent in January, up from a drop of 0.3 percent. Compared with a year ago, prices were up 7.4 percent. Excluding volatile food and energy prices, the index was up 2.3 percent from a year ago, up from 2 percent in December.
The latest inflation report appears to corroborate a broader trend of higher prices across the economy. Last week, the Labor Department reported elevated readings for consumer prices. The consumer price index was up 4.3 percent last month from a year ago, up from a 4.1 percent increase in December.
To be certain, the core rate of inflation - which excludes food and energy - remains closer to the Fed's target of 1 percent to 2 percent. Core consumer prices were up about 2.5 percent in January, up from 2.4 percent in December.
"Months of surging energy prices appear now to be trickling up the production chain to finished goods prices," Kenneth Beauchemin, an economist at Global Insight, a research firm, wrote in a note to clients.
The drumbeat of negative economic data appears to be taking a toll on consumers - at least in the way they perceive the economy, if not in how they spend.
The Conference Board reported on Tuesday that its consumer confidence index fell to a reading of 75 this month, from 87.9 last month. The index was last at this level in early 2003 at the start of the war in Iraq and a time when the economy was growing but unemployment rate was hovering just below 6 percent. By contrast, the unemployment rate was 4.9 percent in January.
"February may go down in history as the month that the previously indefatigable U.S. consumer finally threw in the towel, beaten by a combination of deteriorating labor market conditions, surging prices for food and energy and collapsing house prices," Paul Ashworth, a senior United States economist at Capital Economics, wrote in a note to clients.
The Fed has cut its benchmark interest rate to 3 percent, from 5.25 percent in September, in an effort to offset the drag from the housing market on the broader economy. Its efforts have helped reduce some of the strains in the financial market but they have been less successful in lowering borrowing costs and easing lending standards for businesses and consumers.
In the last several weeks, mortgage interest rates have risen sharply as bond investors have grown more risk-averse. The national average interest rate on a 30-year fixed-rate mortgage rose to 6.04 percent last week, from a low of 5.48 percent in early January, according to Freddie Mac, the government-sponsored buyer of mortgages.
Economists say home prices will remain under pressure for much of the next year or longer because the supply of homes for sale remains high. It has also become harder for home buyers to get mortgages as rates have risen and banks have become more conservative in demanding bigger down payments and more proof of income than they did during the housing boom.
In many parts of the country, specialists note that home prices remain too high based on affordability calculations made using incomes and interest rates. A recent report by analysts at Credit Suisse, the investment bank, said that prices in some metropolitan areas like Phoenix, Miami and Los Angeles would have to decline by 20 percent to 40 percent more than they have already fallen for home affordability to be restored to its long-established level.
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