Bankers bracing themselves for higher interest rates should be aware that there are still signs of deflation, or falling prices, suggesting that the real trend remains toward lower rates ahead.
Fresh economic data last week confirmed that import prices have resumed their long decline, falling 0.2% after a spring up tick led by higher oil prices. Meanwhile, wholesale prices also fell again, slipping 0.1% last month, and the consumer price index has been flat for the last two months.
Inflation, the driving force behind rates, may not be totally dead, but it appears to be increasingly limited to services rather than goods, economists say. Any cooling of the economy, particularly retail sales or the job market, could drive consumer inflation below zero.
"There is simply no evidence of pricing pressures in the U.S. economy," Bruce Steinberg, chief economist at Merrill Lynch & Co., recently told clients.
Several Wall Street economists, including Maury N. Harris of PaineWebber Inc., anticipate U.S. consumer price inflation of only about 2% this year, a moderate pickup from last year's 1.6% rate.
Mr. Steinberg said he expects an inflation rate of about 1.8%, which was the rate of increase for the first five months of this year in the consumer price index. He said the core CPI rate, excluding food and energy prices, has tended to slow in the second half of the year during this decade.
A forecasting tool devised by Mr. Harris' firm-the PaineWebber leading indicator of inflation, a composite index of seven early warning signs of price inflation-recently turned down again by 0.1% after moving upward for three months during the spring.
Even the recent upturn in the index was "much less than pickups during past major periods of accelerating inflation," he said.
That reinforced Mr. Harris' conviction that the Federal Reserve "will not need to raise the current 5% federal funds rate any more this year."
Moreover, international developments like Argentina's recent financial problems tend to propel investors toward the U.S. government securities market as a safe harbor, reducing yields that are the basis for other rates.
The weakness in import prices has been pronounced since mid-1995, and economists believe it has been behind the surprisingly benign inflation outlook.
In the postwar era, inflation has never been this low at such a late stage in the business cycle.
Nonoil import prices fell 1.7% in the 12 months through June.
"Deflationary pressures are present," said Gerald D. Cohen, senior economist at Merrill Lynch. "Only durable industry supply prices rose in June."
The falling prices are the lingering result of Asia's 1997-98 economic crisis and the global problem of overproduction of goods resulting from an investment boom in Third World countries during much of the 1980s and 1990s.
Nevertheless, many economists still think rates are likely to rise before they fall because of the awesome momentum of the U.S. economy.
The Fed may even raise short-term rates another notch at some point, they say.
Rates will probably move up "before the Fed finishes the job and reverses gears," said A. Gary Shilling, an economist and money manager who is the author of a book titled "Deflation."
But Mr. Shilling, who heads his own firm in Springfield, N.J., has not changed his longer-range forecast of significantly lower rates and yields ahead.
He said he expects the dip in rates to occur in the next recession, which could arrive as early as next year, initiating "steady and mild deflation rates of 1% to 2%" in the U.S. economy.