Walls Closing In On The Fed As Inflation Rises

By , Money Morning •

By Jason Simpkins
Associate Editor

Consumer prices rose a seasonally adjusted 0.8% in November, the sharpest increase in more than two years, according to the Labor Department's Consumer Price Index.

Rising consumer prices indicate the threat to the U.S. economy posed by inflation has increased greatly since the Federal Reserve began cutting interest rates with a half-point reduction in mid-September. The central bank added quarter-point cuts in October and December.

Soaring energy prices were the catalyst behind the increase, shooting up 5.7%. Gasoline prices jumped 9.3% and fuel oil costs rose 14.2%, the most since February 2003. Crude oil prices on the New York Mercantile Exchange averaged $94.63 a barrel in November, according to Bloomberg News. Oil hit a record high $99.29 a barrel on Nov. 21.

Food prices also rose for the month, climbing 0.3%.  Still, core inflation - which excludes historically volatile food and energy prices - increased 0.3%, as well. The price escalation may leave the Fed without much room to reduce interest rates any time in the near future.

These escalations in price leave the Fed with less room to reduce interest rates any time in the near future.

If the credit crunch that has plagued the global financial markets throughout the fall intensifies, and the U.S. economy begins to falter as a result, U.S. Federal Reserve Chairman Ben S. Bernanke may find himself pinned in a corner, unable to slash rates for the fourth time without really igniting inflation.

"There is no question inflation is going to remain a concern for policy makers," David Resler, chief economist at Nomura Securities International Inc. (NMR), told Bloomberg. "This certainly will give some policymakers pause about the advisability and desirability of further rate cuts."

There was a spot of good news: U.S. industrial production increased 0.3% in November after a 0.7% drop in October, beating the expectations of many analysts.

Also, in a separate report released Thursday, retail sales rose twice as fast as expected last month. Retail sales were up 1.2% in November; many analysts were only expecting a slight 0.6% increase. 

"This number confirms the solid start to the shopping season we had with 'Black Friday' and 'Cyber Monday'," Wachovia Corp. (WB) economist Sam Bullard told the Financial Times. "Despite all the headlines about subprime... you have to ask yourself, 'Is Middle America really feeling this crisis?'"

However, if energy costs spread and inflation continues to accelerate, the U.S. economy could find itself in a very compromising position. The Fed has already started a trend in the reduction of borrowing costs, but might not be able to follow through without escalating inflation.

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