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Inflation Mixed With Weak Growth Leads To Stagflation

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Bloomberg News

Published: June 18, 2008

The U.S. economy may be suffering from its first bout of stagflation since the start of this decade, reports on housing, prices and manufacturing indicated.

Builders broke ground on 975,000 homes at an annual pace in May, the least in 17 years, and construction permits fell, the Commerce Department reported Tuesday.

Meanwhile, the Labor Department said producer prices jumped 1.4 percent, more than economists forecast. And a report on Tuesday from the Federal Reserve showed that industrial production unexpectedly dropped 0.2 percent.

"The latest round of commodity-price pressure is adding to both inflation and weak growth," said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings in New York. "It's a pretty negative cocktail for the economy and financial markets."

The reports underscore the Fed's dilemma as officials try to prepare investors for an interest rate increase. Too strong a crackdown on inflation may delay an economic rebound, while waiting too long risks a price outbreak that may need even higher borrowing costs to tame.

"We should be moving sooner rather than later," William Poole, a former president of the St. Louis Fed, said in an interview Tuesday with Bloomberg Television in New York. "I don't think you can interpret what's happening with energy as a temporary shock."

"Industrial production is down, that's the stag part, and prices are up, that's the inflation part," said Neal Soss, chief economist at Credit Suisse Holdings in New York. Compared with the 1970s, though, "it's not likely that inflation will get as out of control when wages do not respond," Soss said.

The housing slump has been the biggest drag on the economy, which has slowed sharply in recent months. Builders are smarting as unsold homes, as well as foreclosed homes, pile up. Sagging demand from would-be buyers and - more recently - rising mortgage rates, are adding to builder headaches.

"Builders are doing exactly the right thing: cutting back," said David Seiders, chief economist at the National Association of Home Builders. "Now I'm a little more worried on the interest rate front. I think we'll see mortgage rates recede to some degree. If not, it will be a tougher road for housing than anticipated."

The Fed and the Bush administration are hoping that the central bank's powerful rate cuts since last September, which take months to work through the economy, and the government's $168 billion stimulus effort will help lift the country out of its doldrums.

The producer-price index jump exceeded the 1 percent forecast among economists surveyed by Bloomberg News.

Information from The Associated Press was used in this report.

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