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Recession Fears Are Likely to Overshadow CPI Report

Higher energy and food prices may be hitting many Americans, but fears of a recession are likely to overshadow Wednesday's report on consumer inflation.

Market participants are approaching the U.S. inflation report with the expectation of a tame rise in the gauge for December -- but also with the clear idea that inflation has now fallen behind economic growth as the Federal Reserve's main concern.

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Michael Probst

Fed Chairman Ben Bernanke last week acknowledged the economy faces increased risks of a slowdown and that the Fed stood ready to cut rates to support growth.

Analysts said the remarks showed Bernanke had put the risk of recession ahead of inflation concerns. He added expectations for prices were "reasonably well anchored" and pledged to monitor those expectations closely.

"The Fed has relegated fighting inflation to a secondary status as a policy criteria for the indefinite future," said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida.

While prices at the farm and factory gate showed their biggest annual increase in more than 25 years last year, they dipped in December, according to producer price data released Tuesday.

To investors, that suggested the U.S. Federal Reserve may have more room to head off a business slowdown with more aggressive policy moves.

The producer prices data "essentially gives the Fed the green light to continue cutting interest rates," said Omer Esiner, a market analyst with Ruesch International in Washington.

The reduced inflation concerns mark a turnabout from December, when the Labor Department's report on November consumer price trends startled investors, revealing a 0.3 percent increase in consumer prices excluding food and energy and a 0.8 percent leap in the total Consumer Price Index.

Economists polled by Reuters predicted that in Thursday's report December consumer prices would show both total and core consumer prices rose 0.2 percent, a more subdued inflation
story than that told by the November data.

Even the November numbers are now being read more benignly, and more reflective of surface trends in the economy than any fundamental shift toward higher prices.

Federal Reserve Bank Chairman Ben Bernanke
Pablo Martinez Monsivais
Federal Reserve Bank Chairman Ben Bernanke

"We anticipated a surge in inflation going into year-end because of the move up in oil prices," said Thomas Higgins, chief economist at Payden & Rygel.

The gains in the energy complex seemed more dramatic last month because they came against a drop in oil in the fall. The recent sharp recovery made comparisons "look that much worse,"
Higgins said.

Crude prices, though lower in December, briefly surpassed $100 a barrel this month and are still well above $90.

But for inflation to surge like that again next year, oil prices would have to go to $120 a barrel, Higgins said. But demand for oil could slip in a slowing economy in the months ahead. In general, inflation tends to peak in the middle of a recession, economists said.

"Inflation is the key lagging indicator of the overall economic cycle," said Higgins. "In the middle of the summer, the economy appeared very strong. That strong economy and high energy prices were reflected in the CPI in November."

Slower economic growth in the fourth quarter suggests that inflation will recede in the next three to six months, Higgins added.

While both the CPI and core CPI clearly exceeded the Fed's "comfort range" as of November, the Fed had "telegraphed" that it expected the CPI to exceed that range on a short-term basis, said Margie Patel, senior portfolio manager managing the Evergreen Diversified Income Builder in Boston, Massachusetts.

That expectation was balanced, however, by the Fed's view that in time, the combination of modest excess capacity and subpar economic growth would increase price competition and
lower inflation, she said.

The Fed next meets on Jan. 29-30 when it is widely expected to lower benchmark overnight rates by a hefty half-percentage point to 3.75 percent.