Accelerated inflation over the past three years primarily reflects a powerful run-up in commodities prices. The Fed started to tighten with greater vigor at the end of 2004 and has continued that policy. A review of sensitive and raw materials prices shows most have leveled off in the past year save for fuels, which remain in strong long term uptrends and which, being basic to most commerce, foster a widening in business pricing as commerce seeks to recapture costs from a rising fuels bill.
Looking at oil, priced at $55 plus a barrel, it can be argued that with tight capacity but no shortages, oil should be selling in the low $40s per barrel (equilibrium price at $38.50). So there is a fear premium in the market as well as a few bucks per for speculative zeal. Pardon the presumption, but I doubt the Fed would argue with any of that. Because the Fed cannot know that there will be no significant oil or gas supply blowouts in the months ahead, it would be difficult for them to reason that it is ok to ease up now since the market will surely settle down soon. So, I expect them to lean into the wind for a while longer.
It is also worth noting that for oil to lead the inflation acceleration higher over the next year, it would have to move up to $75 or so a barrel at some point by 2006. I doubt the Fed would be willing to sign off on that either, and I also doubt the central bank would trash the economy if oil did start to move in that direction. This brings us back to perhaps having to lean on the economy a while longer and hope for the best -- that fuel prices will fall in line with the rest.
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