One area of concern on the inflation front not just for the Fed but also for consumers and businesses in general is that of import prices. The latest numbers give a mixed picture on import prices but once one sorts out the volatile commodity prices from final goods for consumers and businesses, there is a general uptrend in import inflation. Import price inflation is arguably stronger than even nonpetroleum prices indicate. Also, recent trends in exchange rates and in some country specific import prices add to the worry.

Overall import price inflation

As an overview, overall import prices jumped 1.0 percent in September, following a 0.3 percent dip the month before. Nonpetroleum import prices seemed benign with a 0.2 percent decline in September, following a 0.1 percent dip in August.

To smooth out some of the monthly volatility, the year-on-year rates can be helpful. Overall import prices have been rising, up to September’s 5.2 percent pace from a recent low of 1.2 percent this past May.  Meanwhile, nonpetroleum import prices have eased somewhat to a year-on-year pace of 2.0 percent in September from a recent high of 3.0 percent in April of this year.

And, of course, it is the recent spike in oil prices that has provided most of the boost in overall import prices with oil import prices returning to a 20.1 percent year-on-year pace in September from a recent low of minus 7.0 percent this past January.

End use categories give insight into rising inflation trends

Imports that are largely inputs have provided much of the upward pressure on imports. These include the industrial supplies component and that for food, feeds, & beverages. Within the latter, the food and beverages portions, however, are generally considered final goods for consumers. Of course, the petroleum portion of industrial supplies have helped push up inflation for that category. Year-on-year, price increases for industrial supplies and for food, feeds, & beverages were 12.0 percent and 8.9 percent, respectively, in September.

What do the details on some key end use components tell us about import prices that more directly affect consumers and businesses? The capital goods component has been keeping overall import prices modest, with this component on a year-on-year pace of 0.5 percent in September. What most have overlooked is that this component had been as low as minus 1.6 percent in April 2006. Other related components also have been accelerating. Consumer goods excluding autos have risen from a recent low of minus 0.3 percent in April 2006 to up 1.5 percent. Also, import prices for autos have risen from 0.2 percent in January 2006 to 1.1 percent this September. While the current year-on-year rates may not seem to be adding much to inflation in the U.S., the “swing” in inflation from recent lows is fairly significant, meaning that import price inflation actually is contributing to an acceleration in underlying inflation from 2006 and even more so compared to very weak import inflation in 2002 when import inflation was quite negative.

The declining dollar raises concern for some country imports

The dollar has been on a long-term decline since 2001 or 2002 against a number of foreign currencies. While the dollar did briefly strengthen in late 2006 and early 2007, the dollar has been on a relatively sharp decline for most of 2007. The decline in the value of the dollar raises U.S. import prices unless foreign producers or U.S. import companies cut profits.  Because of generally long lags between orders for imported goods and their delivery (when import prices are measured), the recent decline in the dollar is still feeding through on import prices.

What are some examples of the declining dollar and import prices? Canada is the U.S.’s biggest trading partner — at least through August 2007 for the cumulative to date for Census based imports. The European Union is a larger trading block and the U.S. does import more from the EU than from Canada but that is for multiple countries. For January 2007 through August 2007, 18.4 percent of goods imported into the U.S. came from the EU and 16.2 percent came from Canada.  However, Canada is about to be overtaken by China as the number one single-country source of imports for the U.S. with China’s share 16.1 percent.

The U.S. dollar has fallen about 38 percent against the Canadian dollar since early 2002.  Canadian import price inflation has gone from minus 4 percent year-on-year in 2003 to currently an average of about 5 percent.

The U.S. Labor Department for most countries gives only “all commodities” prices but for some, there are categories for manufactured goods and non-manufactured goods. Non-manufactured goods can include crude materials, including energy goods. This is the case for Canada and the non-manufactured goods component for imports from Canada are more volatile than for manufactured goods.

Data for the European Union clearly show the lags between changes in exchange rate values and import price inflation. Note that the decline in the dollar that started in 2001 took almost a year to start boosting import inflation. The dollar has been on a long-term decline against the euro, having fallen about 40 since mid-2001. Following a mild rebound in 2005, the dollar has fallen 17 percent since late 2005, indicating that more upward price pressure is coming from imports from the EU.

Until just recently, the dollar actually had been gaining ground against the Japanese yen. This has kept import price inflation from Japan still in the negative range. But if the dollar continues to weaken against the yen, import inflation from Japan is likely to pick up.

Mexico is still a large trading partner with the U.S. with 10.8 percent of imported goods coming from this country. The dollar/peso exchange rate has been rather volatile with no clear trend over the last two years. However, imported goods inflation has picked up but this is likely due to higher oil prices.

The big story is with the Chinese yuan and price inflation for goods imported from China. Of course, the Chinese government had pegged the yuan to the dollar until early 2005. Since early 2005, the dollar actually has dropped moderately – by 9 percent. Partly as a result, year-on-year price increases for Chinese imports have risen from a minus 1.5 percent pace in mid-2005 to plus 1.6 percent this September. This is a 3.1 percentage point acceleration in import price inflation. With China’s share of U.S. imports growing, this trend is adding to U.S. import inflation.

The bottom line

The weaker dollar is gradually fueling higher import inflation especially from countries where the dollar has been particularly weak such as the European Union and even Canada. Because of the lags between when imports are ordered and when they are delivered, we can expect this trend to continue. Further interest rate cuts by the Fed could worsen these trends and the Fed will be mulling over these effects when making policy decisions.