Slowing U.S. Rents Push Inflation Lower, May Delay Fed Shift

The worst U.S. housing slump since the Great Depression has only just begun to effect inflation, indicating that the Federal Reserve can maintain its monetary stimulus well into 2010, economists said. But what then?

Although unemployment is still rising and first time buyer mortgages are going foreclosing and going underwater at record paces, the price of renting a house or apartment, which accounts for 30 percent of the cost of living, has mostly remained unchanged.

The costs of living were mostly unchanged in July from a 2.1 percent drop earlier in the year, excluding food and energy costs, the consumer index has increased slightly at 1.5 percent from July 2008, the smallest gain since February 2004.

“There is a risk that sometime in the next few months, you could see a negative print on core CPI,” said Michael Feroli, an economist at JPMorgan Chase & Co. in New York and a former Fed economist.

“The debate on the Fed will take on a whole new dimension,” Feroli said. “Now people will say, even with growth, the Fed will be a little bit leery here of deflation risks and will want to keep accommodation longer than is priced in the market.”

While a small amount of temporary deflation would be fine a sustained persistent drop in prices would futher hurt the economy by making debts harder to pay and eroding corporate bank profits.

“It might be time to start pushing the panic button on deflation risk investments were it not for signs that the U.S. economy has bottomed,” David Greenlaw, chief fixed-income economist at Morgan Stanley in New York, said today in a note to clients. “We expect core inflation to level off later this year,” he said, because reductions in spare capacity are more important in determining price trends than the amount of the excess.