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Thursday, April 24, 2014         

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Oil prices fuel inflation

The rise in the cost of petroleum will not stop the recovery, Hawaii experts say

By Alan Yonan Jr.

POSTED:


Rising oil prices are causing inflation in Hawaii to grow at a faster rate than previously expected, but so far the increase does not pose a threat to the state's economic recovery, economists say.

Price sensitive

The top and bottom five inflation rates for U.S. cities in 2010:

HIGHEST RATES

Milwaukee: 3.3%
St. Louis: 2.4%
Kansas City: 2.2%
Honolulu: 2.1%
Cincinnati: 2.1%

LOWEST RATES

Seattle: 0.3%
Dallas: 0.5%
Phoenix: 0.6%
Detroit: 0.8%
Miami: 0.8%
Source: U.S. Bureau of Labor Statistics

Hawaii, which suffers disproportionally from higher oil prices compared with other states, had one of the nation's highest inflation rates last year at 2.1 percent. That rate is expected to ease slightly this year, but the state's vulnerability to oil price swings continues to be a problem, according to a recent report by the University of Hawaii Economic Research Organization.

"A significant concern at present is the effect that high energy prices are having on spending by both local consumers and tourists," UHERO said in its quarterly report.

UHERO researchers last week revised upward their inflation forecast for Hono­lulu this year to 1.9 percent from their previous estimate of 1.4 percent, citing higher oil prices. Even at 1.9 percent, however, the rate is low by historical standards. The consumer price index for Honolulu ranged from 5.9 percent to 4.3 percent from 2006 through 2008.

An inflation rate of about 2 percent is considered by the Federal Reserve to have a relatively benign impact on economic growth. As the rate increases it becomes problematic because it begins to erode the value of wages, investments and corporate profits. Higher inflation also often leads to higher interest rates, which increases borrowing costs.

The impact of rising oil prices has been felt around the country in the form of more expensive gasoline. The average gas price in Hawaii was $4.51 a gallon Friday, just 8 cents off the record $4.59 a gallon reached May 6.

But the sensitivity to swings in oil prices is more acute in Hawaii, where more than three-quarters of electricity generation comes from petroleum-fired power plants. The electricity component of Hono­lulu's consumer price index rose by 18.5 percent last year compared with the national average of a 0.2 percent increase. In addition, higher oil prices affect tourism, the state's No. 1 industry. Higher oil prices boost the cost of jet fuel, making it more expensive for visitors to fly to Hawaii.

Although oil prices were in the $112-to-$114 range when UHERO published its forecast, it is predicting prices to drop to $90 a barrel by the second quarter of 2012.

"At these prices we expect any falloff in U.S. consumer spending to be relatively mild and not large enough to significantly undermine the ongoing recovery of travel to Hawaii," according to the UHERO report. "But forecasting oil prices during a period of political unrest in North Africa and the Middle East is clearly a risky business, and any significant further move upward in energy prices has the potential to take all of the wind out of Hawaii's sails."

Outside of food and energy prices, inflationary pressures remain subdued, said Paul Brewbaker, principal of TZ Economics and chairman of the state Council on Revenues.

"Inflationary pressures are not building up because there are still slack resources in the economy, notwithstanding the recovery, and because expectations are low and well anchored and because the Federal Reserve is ratifying those low inflation expectations with appropriately measured monetary policy," Brewbaker said.

UHERO's

Brewbaker said that while higher oil prices will put some upward pressure on inflation during the first half of this year, a subsequent decline in prices will "reverse that influence."

"Oil will only have a temporary, passing effect on ‘headline inflation' this year," Brewbaker said.

Inflation at the national level also has remained relatively subdued despite oil prices. The Federal Open Market Committee — which sets monetary policy for the central bank — has kept the benchmark Federal Funds rate near zero since 2007 as part of its strategy to keep borrowing costs down to stimulate economic growth. It widely believes that once the Fed sees signs that inflation is beginning to accelerate, it will begin raising rates to keep inflation in check.

There is some debate, however, on whether the FOMC is getting behind the curve on inflation.

Federal Reserve Chairman Ben Bernanke has led a group of top decision-makers who don't believe the central bank needs to hurry to raise rates because, they say, increases in the prices of oil and other commodities will have only a temporary impact on broader inflation.

But others, including Philadelphia Federal Reserve President Charles Plosser, have voiced concerns that the Fed needs to act more aggressively on rates to stop inflation before it has a chance to take hold.






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