Inflation Returns Meekly, But Still Overpowers Deposit Rates

Inflation returned to positive territory in May, but just barely. The continued quiet on the inflation front is good news for consumers -- and for the Federal Reserve.

Inflation's gentle return

The Bureau of Labor Statistics announced Tuesday that the Consumer Price Index (CPI) rose by just 0.1 percent in May. This was just the second rise in the CPI in the past seven months, and the 0.1 percent increase is consistent with the 1.4 percent total increase over the past 12 months.

This kind of mild inflation should be very comforting for the financial markets. Declining prices would indicate deflation and raise concerns that the economy is weakening. On the other hand, stronger inflation would be likely to push interest rates sharply higher, creating a stiff headwind for stocks, real estate and other asset prices. In contrast, a mild increase falls right between these two extremes, causing a minimum of disruption to the economy.

May's inflation figures even indicate an unusual degree of consistency across all sectors, so there seem to be no potential trouble spots developing for prices. Most notably, energy prices have moderated considerably, which is a key to keeping inflation on a steady course.

What the latest CPI number means

A mild inflation number is always worth a sigh of relief. It's not going to put anybody back to work, but at least fast-rising prices are one problem consumers don't have to worry about right now. Here are some other implications of the latest CPI release:
  1. Depositors lose -- again. Low inflation should be good for depositors, because it helps keep the purchasing power of their deposits intact, but current interest rates on savings accounts and other deposits are so low it really leaves no margin for inflation. With rates on savings accounts averaging 0.06 percent, even May's slight 0.1 percent rise in the CPI was enough to wipe out more than a year's worth of interest in a single month.
  2. The rise in mortgage rates may slow. Mortgage rates have been rising steadily for six weeks, on the strength of improved economic data and speculation about when the Federal Reserve will end its intervention to keep interest rates low. Evidence that inflation is remaining tame could take some of the urgency out of the rise in mortgage rates.
  3. It buys the Fed some time. Speaking of the Fed, a moderate inflation number is good news for them, because it means they can remain focused on nurturing economic growth. Higher inflation might have forced the Fed to cut back its stimulus sooner than planned, but so far inflation seems to be cooperating.

With inflation well under 2 percent annually, it leaves some room for prices to rise as the economy heats up, without getting out of control. The key for consumers -- and rates on savings accounts -- will be for that economic strength to come around before inflation starts to accelerate.