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PPI Flat as Lower Tobacco Prices Offset Surging Oil

The numbers beat expectations.

Inflation at the wholesale level was unchanged in January, as a sharp drop in tobacco prices offset the strong gains in oil prices.


Labor Department's producer price index

was flat in January, indicating that the breakneck pace of the economy is not putting significant inflationary pressure on the economy. Meanwhile core inflation, which excludes the often-wide swings in food and energy prices, fell 0.2%, largely due to a sharp drop in the cost of cigarettes.

The news surprised economists, who had been looking for a 0.2% increase in overall producer inflation and a 0.1% increase in core inflation.

The moderation in prices was largely due to a sharp 4.2% decline in the cost of cigarettes. Cigarette makers, facing shrinking ranks of smokers, have been holding prices lower in an attempt to maintain market share.

"Once again, tobacco prices are driving the overall direction of producer prices," said Daniel Laufenberg, chief U.S. economist at

American Express


But overall prices would have still been subdued even if not for the tobacco effect. The Labor Department said that had it not been for the decline in the cost of tobacco, the core PPI would have risen 0.1% in January, matching estimates.

The benign readings in other areas, such as automobiles, furniture and capital equipment, were more proof that ongoing gains in the average output of U.S. workers, driven by strong advances in computer technology, are allowing the economy to grow quickly with little sign of meaningful inflation.

"Productive growth is, by nature, non-inflationary," said John Liscio, publisher of

TheStreet Recommends

The Liscio Report

, a publication which tracks economic fundamentals for investors.

The largest inflationary influence in January was energy prices, which rose a dramatic 6.2%, as the price of crude oil jumped from about $24 per barrel to nearly $30 per barrel in the month.

But economists say that the spike in energy prices will probably not have a lasting effect on inflation, and does not seem to be of concern to

Federal Reserve

policymakers because it is seen as a temporary phenomenon.

In a speech Wednesday,

Cleveland Federal Reserve

president Willam Pool said, "I really don't think that oil prices will be the trigger or catalyst for a generalized outbreak of inflation."

Instead, federal officials are fearing that a shrinking pool of available workers in the U.S. will eventually start pushing up wages faster than productivity is pushing up output. Companies would then need to pass on the increased labor costs in the form of higher prices for goods and services.

Based on that fear, the Fed has raised short-term interest rates by a full percentage point in the past year, trying to curb the strong economic growth that has tightened labor conditions. If wages start rising significantly, consumers will have more money to buy the same amount of goods, which will lead prices to rise.

Most economists expect the Fed to continue raising interest rates, in part to try to curb the strong job-market growth that could spark an outbreak of inflation. Higher rates usually curb growth by making it harder for businesses and consumers to borrow and spend.

However, while inflation measures such as the PPI remain low, the Fed has the ability to raise rates gradually.

"The obvious risk at this point is that there could be an eventual outbreak of inflation, but given the subdued inflation environment the Fed has the luxury of doing so slowly to avoid jolting the financial markets," added Laufenberg.