With Costs Rising,
Companies Move
To Increase Prices
Mix of Inflation, Slowdown
Poses Challenge for Fed;
Energy Takes Broad Toll
Dow Surges on GDP Figures
By AMY MERRICK and MARK WHITEHOUSE
July 29, 2006; Page A1
After years of caution, companies are raising prices on a range of consumer products, from cereal and beer to washing machines and toilet paper.
This past week, cereal-maker Kellogg Co. and brewer Anheuser-Busch Cos. both said prices on their products are heading up. Airlines, after a period of cutting back, are flying with full planes -- and charging more for seats. Cigarettes and tissues are getting more expensive, and soon cruises may too.
Broadly, consumer prices are rising more quickly than at any time in the recent past, after years in which many consumer-good companies complained they had no ability to raise prices to cover costs or increase profit margins. On Friday, the government reported that its index of core personal consumption prices -- the gauge the Federal Reserve watches most closely -- rose at an annualized rate of 2.9% in the second quarter. That was the highest since 1994. Much of that rise has been driven by a surge in rents, but goods prices also now appear to be turning up.
Meanwhile, real growth in gross domestic product -- a broad measure of economic activity, adjusted for inflation -- slowed sharply to a 2.5% seasonally adjusted annual rate. In the first quarter, it was a strong 5.6%.
Stocks rallied Friday in part on the hope that the GDP slowdown might persuade the Federal Reserve to pause at its Aug. 8 meeting in its campaign to raise short-term interest rates, which have gone to 5.25% from 1% in June 2004. The Dow Jones industrials surged 119.27 points, or 1.1%, while the Nasdaq was up 1.9%.
But the mix of rising prices and slowing growth presents a quandary for Fed Chairman Ben Bernanke and his colleagues. They must decide whether the surge in prices stems largely from temporary cost increases of energy and other commodities, or broader changes in the economy, such as companies using up inventories and squeezing out excess capacity. If it's the latter, they may continue to increase interest rates, even at the risk of tipping the economy into recession.
"That's part of the debate the Fed is having -- trying to figure out how persistent this is and how much of it is the pass-through of a one-off rise in energy prices," said Bruce Kasman, chief economist at J.P. Morgan Chase & Co.
The evidence is mixed. There's no question that high oil prices and other rising energy costs are a big factor driving inflation. Global demand for construction, mining and drilling also has helped, pushing up prices of steel, aluminum and other commodities, on average, by about 25% from a year ago.
Meanwhile, the Fed's "beige book," a roundup of anecdotal reports from its 12 districts, this past week reported that wage and price increases were generally modest. But it also found scattered reports of increases in "manufacturers' and retailers' ability to pass [energy] cost increases on to final prices."
Some economists are skeptical consumers will long accept higher prices. "If the economy slows, which I think it is doing, then these price increases won't stick," said Nancy Lazar, economist at ISI Group, a New York research group and brokerage firm.
At the same time, price increases can feed on themselves. "When cost pressures are general, such as the increase in transportation costs, then you know that your competitor is feeling the same cost pressures as you," said Don Ratajczak, a consulting economist in Atlanta. "Instead of stealing sales from you when you raise prices, they follow the price lead to recapture the higher costs they may pay."
Spreading Impact
The impact is being felt across many industries. Food companies, for instance, are facing a squeeze not only from fuel but from wheat, corn and sugar prices. Interstate Bakeries Corp., the Kansas City, Mo., maker of Wonder Bread, said it's responding to price increases in commodities such as flour by raising prices over the next two months. Kellogg, of Battle Creek, Mich., blamed escalating costs for energy and other raw materials for its decisions to raise prices on some cereal brands and frozen foods.
In a conference call this past week, Kellogg President and Chief Operating Officer David Mackay said retailers "are feeling a little of the cost pressures we are, with fuel and energy and some of the commodities. They buy packaging like we buy packaging. So they certainly understand the cost pressures...."
Some shoppers say they understand those pressures too, though they're not happy about them. Shopping at a Jewel grocery store in Chicago Friday, John Lee said he noticed prices going up. "I understand why -- it just makes me more angry at the oil companies," said the 41-year-old elementary-school teacher.
Higher gasoline and housing prices are now conditioning customers to expect inflation, said Sung Won Sohn, chief executive of Hanmi Bank in Los Angeles. "The sellers have a good argument and the buyers have been expecting higher prices, so they are beginning to accept it," he said. The U.S. hasn't seen a similar consumer mindset since the high inflation of the early 1980s, Mr. Sohn said.
Beneath the aggregate data, the picture in stores is mixed. Prices of appliances, for example, appear to be decelerating. They rose at an annualized rate of less than 1% in the first six months of this year, compared with almost 3% last year. Prices for tobacco, movies and meals at restaurants are slowing, while prices for apparel, alcoholic beverages and furniture are speeding up.
Where prices are going up, they often are maintaining or even boosting corporate profits. In reporting a 7.4% increase in second-quarter earnings this past week, for instance, Anheuser said it's seeing much less discounting of beer this summer than it did last year. The St. Louis brewing giant said it plans to begin raising prices in the fourth quarter and to increase prices on most of its beers -- which include Budweiser and Michelob -- in 2007.
Reynolds American Inc., the cigarette maker in Winston-Salem, N.C., said it is getting a boost to its bottom line from higher prices on its Camel and Kool cigarette brands. Its second-quarter earnings jumped 50% from a year ago. Similarly, Sherwin-Williams Co. of Cleveland said rising prices on its paints helped its second-quarter net income increase more than 20%, despite some cooling in the housing market.
Also seeing gains from price increases was Kimberly-Clark Corp., of Irving, Texas, which this past week credited its 4% gain in second-quarter sales to a 2% overall jump in prices. However, as prices for products such as Kleenex and Cottonelle toilet paper rose about 5% in North America, sales volume fell 4%.
Reduced Capacity
For some industries, notably airlines, a reduction in excess capacity price has created the opportunity to boost prices. The airline industry, facing soaring jet-fuel and labor costs among other problems, has undergone several years of heavy restructuring, cutting back flights while nudging up fares for the past year or more.
The latest fare increases helped lift most U.S. airlines to strong second-quarter profits. The revenue that carriers collect for each seat flown a mile, a key industry measure, is up by more than 10% from a year ago.
The Transportation Department reported this past week that the Air Travel Price Index, which examines prices in the 85 largest U.S. airline markets, rose 10.3% in the first quarter from a year earlier, the largest year-to-year rise since the department started the index in 1995. The government said the index level in the first quarter was topped only by the fare levels in early 2001.
Prices also may be headed up on the ocean. Carnival Corp., the largest cruise operator, is imposing a surcharge of about $12.50 to $18.75 this summer on one of its European brands and says it may implement the charge in the U.S. if passengers don't balk.
Officials at Miami-based Carnival previously had said they believed customers would be irritated at such charges from highly profitable cruise companies. But fuel costs surged 24%, or $100 million, during the second half of 2006 from a year earlier, said Howard Frank, Carnival's vice chairman, in a recent interview. That made it time to gauge customer reaction.
Whirlpool Corp., too, said it will try to push through price increases averaging 6% to 12% this year. The Benton Harbor, Mich., manufacturer of refrigerators, washing machines and other appliances, said it expects its materials costs to increase $150 million this year. Rising expenses, especially for oil-based resins and base metals, have been taking a bite out of its earnings since mid-2004.
"We are driving record levels of productivity in our business, and it's justified that the...raw material increases are passed through to the marketplace," Chief Executive Jeff M. Fettig said. Whirlpool also might find it easier to raise prices after acquiring one of its top competitors, Maytag Corp., earlier this year.
Write to Amy Merrick at amy.merrick@wsj.com and Mark Whitehouse at mark.whitehouse@wsj.com |
