Consumer Spending Falls Off

By MICHAEL M. GRYNBAUM

Published: January 31, 2008

Consumer spending slowed in December and inflation continued to rise, the government said Thursday, leaving the Federal Reserve little leeway as it ponders policy decisions in the months ahead.

Spending by consumers, which accounts for more than two-thirds of the nation’s economic growth, rose by an anemic 0.2 percent in December after jumping 1 percent in November. Adjusted for inflation, spending was flat for the month.

Economists have predicted a significant downturn in spending as consumers grapple with record-high oil and food prices. The report from the Commerce Department reinforces the disappointing holiday sales figures that leading retail chains released in the last few weeks.

“With the labor market weakening and housing remaining a huge weight, the pace of consumer spending growth ought to remain painfully slow in the months ahead,” wrote Joshua Shapiro, an economist at MFR, a research firm.

As spending slows, prices continue to rise, a combination that has some economists suggesting the United States could face a period of stagflation. A closely watched gauge of inflation ticked up last month, to a 2.2 percent annual rate; that figure, the core personal consumption expenditures deflator, excludes prices of food and energy.

Over all, prices in December were 3.5 percent higher than they were a year ago, far above the Fed’s so-called “comfort zone” of 1 percent to 2 percent.

High inflation puts the Fed in a difficult situation. The central bank primarily sets monetary policy by changing a key interest rate. Lowering the rate stimulates growth, but also causes prices to rise, creating an increased inflation risk.

In its most recent policy statement, released Wednesday, Fed officials said they expect inflation “to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.”

The Commerce Department report also showed that personal income levels rose 0.5 percent in December. Disposable income — after-tax salary adjusted for inflation — rose 2.1 percent since December 2006.A separate report from the Labor Department showed that new unemployment claims, a leading indicator of the labor market, increased by 69,000, to 375,000, in the week ended Jan. 26. It was the highest level since October 2005.

Meanwhile, a Chicago-based barometer of business activity fell in January. New orders dropped sharply to the lowest level since May 2003, and the price of production rose, underscoring the impact of high inflation on business owners.

“These numbers are not at recession levels, but they are only one bad month away,” wrote Ian Shepherdson, a London-based economist at High Frequency Economics, in a note to clients. “The manufacturing sector is coming under increasing pressure.”

The report, issued by the Chicago arm of the National Association of Purchasing Management, may not bode well for the ISM manufacturing index, a closely watched indicator of United States business activity. The index for December will be released on Friday.

Employment at Chicago-area businesses also fell this month. Over all, the index dropped to 51.5 from 56.4 in December.