Today’s update on consumer prices for June is one more bit of bad news on inflation. But maybe, just maybe, the inflationary momentum is about to break for a while.
Before we dive into what may, or may not happen, let’s review the latest numbers. Consumer prices surged by 1.1% last month, the Bureau of Labor Statistics reports. That’s the highest monthly gain since 1981. On an annual basis, CPI rose by 4.9% through last month–the highest since 1991.

There’s no doubt what’s behind the price hikes: energy prices jumped 6.6% last month, the government reports. The surge in energy costs spilled over into transportation, which climbed 3.8% last month. Food isn’t lying low either, although its 0.8% advance in June looks modest by comparison with energy and transportation.

Once again, if you take out food and energy prices, the resulting core-CPI is up a modest 0.3% last month and for the past year has climbed just 2.4%, which is middling based on the last three years.
The Fed, of course, likes to focus on core inflation, in part because a number of economic studies have shown that it’s a better predictor of top-line inflation. That’s certainly been true in the past, although there’s a danger that the old relationships are breaking down, as we’ve discussed many times over the years, including here and here.
It doesn’t take a Ph.D. to recognize that a slump in oil prices would go a long way toward salvaging the belief in core inflation as the better yardstick for setting monetary policy. As luck would have it, crude prices dropped sharply yesterday. The August ’08 contract in New York shed more than 4% yesterday. Even so, we’ll need a lot more down days to take the edge off inflation. Crude, after all, is still lurking at almost $140 a barrel as we write.
Still, the prospect of demand destruction for energy, along with a lot of other goods and services can’t be dismissed at this point. The economies of both the U.S. and Europe look set for more weakness in the balance of this year and probably well into 2009. The underlying factors driving the weakness are by now familiar, including a liquidity crisis in the financial sector, a real estate correction, rising unemployment, and soaring commodity prices. All of which promises to nip demand in the bud in the coming months and quarters.
Recession, in short, is still very much a threat. In addition, the prospect of slow/no growth economy after the technical end of the recession remains a distinct possibility. As such, one can imagine that oil prices will correct, or at least stop rising once the market fully factors in the economic outlook. In turn, an oil price correction would go a long way toward keeping inflation in check from here on out.
But let’s not get too giddy. Rising commodities prices generally, and oil in particular, are based on a fundamental shift in the supply/demand equation in the global economy. To restate the obvious: demand has risen sharply in recent years while supply growth has lagged. Perhaps we’ll enjoy a break from the trend and see energy prices fall in the wake of economic slowdown or worse. Maybe. It all depends on how much of a global slowdown we’re looking at, and how much influence the U.S. has over oil prices these days. The latter subject is open to debate, thanks to the rise of China, India, etc. and the relative maturing of the U.S. economic growth outlook compared with emerging markets.
In any case, it wouldn’t surprise us to see oil prices drop sharply from current levels. Volatility and commodities, after all, are old friends, regardless of economic conditions. Longer term, however, it’s unlikely that oil prices are due for a sustained fall. Noise may dominate the short term, but supply and demand dictate price trends over time. That means that while inflation pressures may ebb for a time, the respite will only be temporary, assuming it comes at all.