Businesses Getting Squeezed on Prices

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August 16, 2005--Economic data released today by the Department of Commerce raises concerns for the short-term profitability of small businesses.

The federal Bureau of Labor Statistics reported that the consumer price index rose only .5% in July, despite a 14% rise in energy costs. The so-called core inflation, which excludes energy and food prices, rose only 2.1%.

The government also released employment data for July, which showed that unemployment remained at 5% amid a 1.8% rise in industrial production.

Low core inflation suggests that businesses may be losing the ability to pass along price increases resulting from a tight labor market and rising energy and health care costs. If this happens, businesses may have to rein in hiring and investment, and focus on liquidating inventories.

"It's not clear that we're going to see a profit squeeze," said Ken Goldstein, senior economist with the Conference Board. "But the data released today moves that worry a bit closer."

Brian Headd, an economist with the Small Business Administration, said that small businesses face a greater challenge in maintaining or expanding operations when profits are squeezed because they don't have the "war chest of savings to weather these conditions."

While energy costs indirectly affect the cost structure of most businesses, rising medical costs have an immediate impact. The inflation data released today showed that medical care increased 4.2%, double the pace of core inflation.

An August report from the National Federation of Independent Business found that the cost and availability of insurance is the foremost concern among businesses. The report also found that fewer businesses surveyed feel they can pass along costs to customers.

But David Huether, chief economist of the National Association of Manufacturers, focused on the implications for fiscal policy. "The main story is that the rise in energy prices is not spilling into other sectors and areas of consumption," he said. Huether expects the Fed to maintain what he considers an "accommodative" interest rate policy.

This is especially important for small businesses which depend heavily on bank loans to finance growth.