Falling Inflation and Interest Rates Defy Expectations

The Bureau of Labor Statistics released the Consumer Price Index (CPI) figures for April, and the results defied the conventional wisdom that a strengthening economy should lead to higher inflation.

This widely-followed measure of inflation indicated that overall prices actually fell in April, by 0.1%. While inflation increased by 2.2% for the 12 months ending April 30th, the recent trend shows prices hitting a wall: the change in CPI for the past three months has been 0.0%, +0.1%, and -0.1%, respectively.

There are plenty of components to inflation, but with oil prices having dipped below $70 a barrel recently, at least one important factor has declined so far in May, meaning that there may be more low inflation numbers on the way -- or even a return to deflation.

Perhaps the greatest significance of the latest inflation release is what it says about the economic recovery. Clearly, retailers do not yet have pricing power in the marketplace. Without pricing power, employers may lack the confidence to start hiring aggressively, and without a pick-up in employment, this economic recovery may be dead in the water.

Ordinarily, deflation holds a silver lining for bank depositors and other savers -- it represents an increase in their purchasing power. Still, even at a modest 2.2%, inflation over the past twelve months has exceeded most savings account rates, money market rates, and short-to-intermediate CD rates. Furthermore, May so far has seen a drop in bond yields, which indicates that super-low bank rates may be with us a little longer.

It's important not to overreact to any one piece of economic data, but when a figure goes against the expected trend, as is the case with the April inflation release, it is certainly worthy of notice.

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