US Consumer Prices Likely Hit 10-Month High In Feb: Preview

However, the Federal Reserve's policy-setting Federal Open Market Committee emphasized earlier this week that the surge in energy prices is temporary and that inflation will remain below the Fed's target rate of 2 percent in 2012.

The consumer price index, or CPI, increased 0.4 percent, its biggest gain since April 2011, according to the median forecast of economists surveyed by Thomson Reuters before Labor Department data to be released Friday. In January, consumer prices climbed 0.2 percent.

The top-line number is all energy, said Steve Blitz, chief economist at ITG Investment Research.

In February, spot prices of West Texas Intermediate and Brent crude oil rose by $9 and $10 per barrel, respectively. Nationwide, the average retail price of regular-grade gasoline increased by about 28 cents per gallon.

The U.S. Energy Information Administration expects the monthly average regular-grade gasoline retail price to peak in May at $3.96 a gallon.

According to the Department of Energy, crude oil accounted for nearly 70 percent of the cost of gasoline in 2010.

The EIA projects that vehicle-fueling costs for the average U.S. household will be about $238 more in 2012 than in 2011.

Blitz said the increase in energy prices this time around isn't due to great oil demand, as Europe and China are slowing down, but more because of concerns regarding Iran's nuclear program and a potential scarcity because of possibility of war.

With Middle East tensions continuing to linger, we suspect energy prices will remain elevated in the coming months and pose a significant downside risk to the economic outlook as firms and consumers grapple with higher petroleum prices, Sam Bullard, a senior economist at Wells Fargo Securities LLC, wrote Thursday in a research note.

However, the Fed doesn't seem worried.

In its policy statement Tuesday, the FOMC said the recent increase in oil and gasoline prices will push up inflation temporarily. Central bank officials, however, said that following the run up, annual inflation will stay at or below the 2 percent target.

Core CPI

The so-called core CPI index, which excludes volatile food and energy prices, likely rose 0.2 percent in February, similar to January's pace, economists forecast.

The core (gauge) is in the process of creeping higher on a year-over-year basis, Blitz said, adding that inflation always runs with a lag of about a year or so from the general economy.

Clothing retailer Gap Inc. (NYSE: GPS) said higher commodity prices continue to squeeze the company's profit margin. The apparel prices index rose sharply in January by 0.9 percent.

Clearly, cotton inflation had a significant impact on our average unit costs in 2011. As is commonly known in the sector, spring 2012 costs are up, though up less than holiday 2011, Chief Financial Officer Sabrina Simmons said on a Feb. 23 conference call with analysts.

Stagnant Wages

U.S. employers hired 227,000 workers in February -- the third straight month more than 200,000 workers found jobs - and unemployment held at a three-year low of 8.3 percent.

However, personal incomes are barely keeping pace with inflation. Real disposable income decreased 0.1 percent in January, according to the most recent data from the Commerce Department. Meanwhile, consumer spending in January, the latest data available, came in flat for a third straight month.

Prices are going up, at the same time, wages are not rising as rapidly, Blitz said. As long as we have this gap, the Fed is not worried (about inflation pressure).

Wages govern how high prices can go because consumers will eventually pull back if the pace of wage increases can't keep up with the increase in prices.

For inflation to go up, you need wages to go up as well, Blitz added.

The Fed is forecasting that the inflation gauge it uses will increase by about 1.6 percent in 2012 and rise to about 1.7 percent in 2013.

Separate reports showed the February producer price index, a measure of wholesale prices, posted its largest gain in five months boosted by higher energy prices, while imported food prices recorded its largest drop in three years.

Quantitative Easing

Observers believe current economic conditions don't warrant a third round of quantitative easing, or QE3. The first two rounds of bond-buying by the Fed took place during 2009-2011.

Fed officials offered few clues about QE3 in their March FOMC meeting statement. The minutes of their meeting, to be released April 3, may provide more insight.

I don't believe the Fed is going to do another round of quantitative easing, Blitz said. What would drive the Fed to do that, if they do it, would be some sort of an economic event that threatens a decline in the equity markets.