Consumers are squeezed as inflation outpaces wages

WASHINGTON -- American families were squeezed last year as their inflation-adjusted weekly wages fell 1.6 percent Ã¢â‚¬â€ť the sharpest drop since 1990 Ã¢â‚¬â€ť even as consumer prices rose only modestly.

Their spending power sank in the face of falling wages, job losses and higher prices for energy, medical care and education. Slack pay and scarce job creation are slowing consumer spending, hindering the economy's ability to mount a strong recovery.

Overall consumer prices rose 2.7 percent last year, the Labor Department's Consumer Price Index showed Friday. A surge in energy prices last year offset the biggest drop in food costs in nearly a half century.

Core inflation, which excludes the volatile food and energy categories, rose 1.8 percent for the 12 months ending in December. It matched the 1.8 percent rise in core inflation in 2008. Both gains were the smallest since a 1.1 percent rise in 2003.

For December, the CPI rose a modest 0.1 percent. Excluding food and energy, prices were also up just 0.1 percent last month.

Also Friday, the Federal Reserve said industrial production rose 0.6 percent in December as unusually cold weather helped energy utilities offset a small drop in manufacturing. It was the sixth straight monthly gain in production. But the mixed picture shows the economic recovery remains tepid, as consumers and businesses spent too little to spur the production of more factory goods.

The 2.7 percent rise in overall consumer prices for 2009 followed a 0.1 percent increase in 2008, which had been the smallest gain in more than a half century.

Energy costs for the 12 months ending in December shot up 18.2 percent. That was the biggest jump since 1979, after they had dropped 21.3 percent in 2008. The energy surge was led by higher gasoline costs, which rose 53.5 percent after falling 43.1 percent in 2008.

Food prices swung in the opposite direction. After rising 5.9 percent in 2008, they fell 0.5 percent for the 12 months ending in December, the biggest drop since 1961.

Core inflation is expected to remain low in 2010 as the country struggles to emerge from the deepest recession since the 1930s. Yet moderate price increases are small comfort for workers whose wages have lagged behind even slight inflation.

The 1.6 percent drop in average weekly earnings for nonsupervisory workers was the worst annual performance since a 2.5 percent decline in 1990. Weekly earnings have fallen in five of the past seven years, underscoring the pressures American households were facing even before the recession began.

The 1.8 percent rise in core inflation for 2009 and 2008 left prices increases within the comfort zone of the Federal Reserve. The scant inflation allows the central bank to keep a key interest rate at a record low to try to invigorate the economy.

Those low rates and huge amounts of stimulus money pumped into the economy by the government would normally raise alarms about inflation. But the sluggish recovery has kept a lid on price increases.

The Fed isn't expected to start raising interest rates until the unemployment rate, now at 10 percent, begins coming down. That might not happen for several months.

The economy lost a net total of 85,000 jobs in December. High unemployment and a lack of hiring have depressed wages and left consumers reluctant to spend.

One of the factors keeping core inflation under control is housing costs. They dropped 0.3 percent for the 12 months ending in December, the biggest annual decline on records dating to 1968. A glut of single-family homes on the market and record apartment vacancy rates have put pressure on housing prices.

Some costs have continued to rise even during the hard times. Medical costs rose 3.4 percent in 2009, the largest increase since a 5.2 percent increase in 2007. Education costs rose 4.7 percent last year.