The real U.S. cost of living is soaring

The cost of living in the U.S. rose more than forecast in May as prices for everything from autos to hotel rooms climbed, signaling raw-material expenses are filtering through the economy.

The consumer-price index increased 0.2 percent last month and was up 3.6 percent from May 2010, the biggest year-over-year advance since October 2008, according to figures from the Labor Department today in Washington. Another report showed factory production rebounded last month, easing concern the industry that helped propel the U.S. out of the recession was stagnating.

Prices excluding food and fuel climbed 0.3 percent in May, the biggest one-month gain since July 2008, highlighting efforts by companies like McDonald's Corp. (MCD) and Abercrombie & Fitch Co. (ANF) to charge customers more. The report may concern Federal Reserve policy makers like Chairman Ben S. Bernanke who are trying to maintain record stimulus while avoiding inflation.

"Economic growth will continue to accelerate and inflation should accelerate with it," said Omair Sharif, an economist at RBS Securities Inc. in Stamford, Connecticut. "The Fed is going to have to start worrying."

A third report showed manufacturers in the New York region unexpectedly turned pessimistic in June, a sign the industry still faces parts shortages following the disaster in Japan.

Stocks dropped as European officials failed to agree on a rescue plan for Greece and on concern over the slowdown in the New York Federal Reserve Bank's Empire State Index. The Standard & Poor's 500 Index dropped 1.3 percent to 1,270.7 at 12:02 p.m. in New York. Treasury securities rose, sending the yield on the benchmark 10-year note down to 2.99 percent from 3.10 percent late yesterday.

Survey Results

The median forecast of 79 economists surveyed by Bloomberg News projected consumer prices increased 0.1 percent in May. Estimates ranged from declines of 0.2 percent to gains of 0.4 percent. Economists projected the core gauge, which excludes food and energy, would rise 0.2 percent.

The core CPI climbed 1.5 percent from May 2010, the most since January 2010.

The gain in May core prices was led by a 1.1 percent advance in the cost of new vehicles, which may reflect supply shortages caused by the disaster in Japan. At the same time, the cost of other goods and services also advanced. Hotel rates climbed 2.9 percent last month, clothing prices increased 1.2 percent and recreation expenses increased 0.3 percent.

"We're seeing a broad-based bleed-through of energy and commodity-price pressures into components throughout the core," said John Herrmann, a senior fixed-income strategist at State Street Global Markets LLC in Boston, who correctly forecast the gain in core inflation. "The Fed has to be more adamant about their credibility as an inflation fighter."

Smaller Margins

Abercrombie & Fitch's Chief Financial Officer Jonathan Ramsden said on June 8 that rising costs would narrow the teen retailer's second-quarter profit margins. The apparel industry is facing higher costs for cotton, oil and Asian labor. Abercrombie plans to raise U.S. prices in early September, Ramsden said.

Food costs increased 0.4 percent, today's report showed. The 1.5 percent jump in meats, poultry, fish and eggs was the biggest since November 2003.

McDonald's, the world's largest restaurant chain, said last week that U.S. sales at stores open at least 13 months advanced 2.4 percent, the smallest monthly gain since February 2010. The Oak Brook, Illinois-based company has raised prices over the past year to offset surging meat costs, which analysts said prompted customers to buy cheaper items on the menu.

Bernanke's View

Fed Chairman Bernanke said the U.S. economy, which slowed in the first quarter, will likely pick up as fuel costs fall and as factories in Japan recover from the March earthquake and tsunami. There isn't "much evidence that inflation is becoming broad-based or ingrained," Bernanke also said at a June 7 speech in Atlanta.

The central bank's preferred price gauge, which excludes food and fuel, rose 1 percent in April from a year earlier. Fed policy makers aim for long-run overall inflation of 1.7 percent to 2 percent, according to their April forecast.

Fed officials are discussing whether to adopt an explicit target for inflation, according to people familiar with the discussions. Policy makers have argued that greater clarity on inflation could benefit labor markets by helping the central bank anchor price expectations even when rates are low.

Factory Production

Output at factories, mines and utilities rose 0.1 percent in June after no change the prior month, figures from the Federal Reserve showed. Factory production climbed 0.4 percent, led by the biggest gain in business equipment output in four months.

Manufacturing may pick up in coming months as Japan recovers. Overseas demand and business spending may also spur sales of U.S.-made equipment and technology, helping bolster the industry that's been a mainstay of the recovery.

"Underlying manufacturing activity is relatively healthy," said Sharif. "We are going through a little bit of soft patch that will fade over the next couple of months."

The Federal Reserve Bank of New York's general economic index dropped to minus 7.8, the lowest level since November, from 11.9 in May. Readings greater than zero signal expansion in the so-called Empire State Index, which covers New York, northern New Jersey and southern Connecticut.

Also today, the National Association of Home Builders/Wells Fargo sentiment index fell to 13 in June, a nine-month low, from 16 the prior month. The drop indicates housing will remain a weak spot in the economy.