Image: A poster for mass transit in Palo Alto, Calif.
Paul Sakuma  /  AP
In the last three months, gasoline prices are up by a third and food prices are up 10 percent.
By John W. Schoen Senior producer
msnbc.com
updated 4/15/2008 7:17:34 PM ET 2008-04-15T23:17:34

When the economy slows down, the resulting drop in demand normally takes some of the pressure off inflation. But these are not normal times: Even as the economy is slumping, oil prices are rising and food prices are jumping.

All of which could spell more trouble for consumers in the coming months. Tax filers this week can look forward to some relief from a massive government rebate program. But that one-time shot in the arm won’t help consumers — or the economy — if energy and food prices keep rising.

On Tuesday, oil prices surged to a new high, passing $113 a barrel, and the government reported that prices at the wholesale level jumped 1.1 percent in March.

“These are going up way too rapidly,” said economist Joel Naroff of Naroff Economic Advisors. “This is the money that the average person has to spend, and as a result they don’t have a lot of money left over for other things.”

Food and energy prices tend to move up and down more quickly than other goods, but lately they’ve only been moving in one direction. In the last three months, gasoline prices are up by a third and food prices are up 10 percent.

Analysts take some comfort in the fact that the so-called “core" inflation rate has — so far — remained in check. The hope is that higher food and energy prices haven’t yet spilled over into the prices of other goods.

But if you break down the list of those goods, the price increases have been mildest in so-called capital goods — business machinery and equipment. Price of consumer goods other than food and energy are up 5.5 percent in the past three months. Analysts are expecting that trend to show up in the Consumer Price Index due out Wednesday.

There are multiple causes to the current rise in prices. A falling dollar increases the cost of the steady stream of imported consumer goods made overseas. As the dollar falls, it takes more of them to buy goods priced in stronger currencies. Developing economies around the world are bringing increased demand for raw materials.  Rapid expansion of ethanol production in the U.S. has diverted supplies of corn from grocery stores to gasoline pumps.

Underlying all of these is the rising cost of energy, according to Stuart Hoffman, chief economist at PNC Financial Services Group.

“A lot of this gets right back to oil at $113 barrel and that, to me, is just reverberating through the inflation pipeline — and not just in the in the U.S.,” he said. “We’re seeing global problems on inflation, particularly on the food front in countries where their subsistence level (income) doesn’t give them any room for leeway.”

On Tuesday, Indonesia became the latest country to clamp down on food shipments out of the country to try to maintain supplies. Rising global prices prompted more farmers to sell their crops at export prices that are nearly double local rates.

Major Market Indices

The list of other countries that have placed restrictions on food exports in a bid to secure supplies and limit inflation includes Russia, Vietnam, India, Cambodia and Argentina — the latter is the world’s fourth largest wheat exporter. In Bangladesh, economists estimate 30 million of the country’s 150 million people could be going hungry. Haiti’s prime minister was ousted over the weekend following food riots there.

U.S. households spend a smaller part of their budgets on foods than any other country — some 7.2 percent in 2006, according to the USDA. But food costs in the U.S. are rising faster than they have in 17 years. Eggs cost 25 percent more in February than they did a year ago, according to the USDA. Milk and other dairy products jumped 13 percent, chicken and other poultry nearly 7 percent.

“It’s eating into a lot of peoples’ budgets,” said Naroff. “And we’re beginning to see it already in the retail sales numbers.”

All of which leaves policymakers at the Federal Reserve between a big rock and very hard place. After  the housing slump and mortgage mess threw sand in the gears of the credit markets last summer, the Fed began flooding the financial system with money to get things moving again. But it’s a risky move: too much money sloshing around the economy can also feed inflation.

Central bankers are betting that a slowing economy will help take the pressure off demand for goods — which ordinarily would help tame inflation. But if higher energy prices are the underlying cause of higher prices, the Fed has a lot less room to maneuver. Raising interest rates now to fight inflation runs the risk of further damaging to the financial system and global economy.

“There a lot of bad things that are coming together when it comes to inflation but not a lot of them can be effected by Fed policy,” said Naroff. “What’s the Fed going to do — drive the world into recession so the world stops eating?”

For the time being, the best central bankers can do is signal that their rate-cutting days are numbered.  After slashing short-term rates in half over the past nine months, many economists expect the next move to be a relatively modest quarter-point cut when the Federal Open Market Committee meets at the end of the month.

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