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Federal Reserve chairman Ben Bernanke (J. Scott Applewhite/AP)
Federal Reserve chairman Ben Bernanke (J. Scott Applewhite/AP)

How will the Fed view inflation? Add to ...

The cost of living in the U.S. has increased by only 1.7 per cent over the last 12 months, according to the latest consumer price index for May.

That headline number is significant because for the first time in 16 months CPI inflation has fallen below the U.S. Federal Reserve’s target of 2 per cent.

U.S. stocks have been rising Thursday on the news. The rationale is that lower inflation gives the Fed greater room to stimulate the economy. The Fed’s policy-making committee is meeting next week, and many investors are thinking that further monetary stimulus is now very likely given the weak condition of the domestic recovery and the worsening financial crisis in Europe.

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But it may be wrong to think that May’s 0.3 per cent month-to-month decline in CPI will spur the Fed to re-open the spigot, according to Paul Ashworth, chief U.S. economist for Capital Economics.

Diving into the numbers, he points out that the decline was largely due to the 6.8 per cent drop in gasoline prices and the 4.1 per cent falloff in natural gas prices. In addition, food prices remained the same. Core consumer prices, however, actually increased by 0.2 per cent in May, leaving the annual rate of core consumer inflation unchanged at 2.3 per cent. And the three-month annualized rate accelerated to 2.7 per cent, up from 2.3 per cent, he noted.

These details mean the Fed may in fact still be reluctant to launch additional stimulus measures as early as next week.

But Mr. Ashworth says there’s a good chance that core inflation will soon start to ease, gradually sliding below the Fed’s 2 per cent target. He points out that the big drivers behind the core increase in May were rising prices for clothes, airline tickets, hotel rooms and used automobiles. But those trends should shift due to the decreasing cost of cotton, fuel and new car prices, he said.

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