NEW YORK (CNN/Money) - When economists talk about inflation being under control, they're often ignoring energy prices, which can be wildly volatile.
Unfortunately, consumers, the life-blood of the U.S. economy, can't ignore them -- and if a recent surge in oil and gasoline costs lingers for long, it could keep a lid on economic growth in coming months.
On Friday, the Labor Department said its consumer price index (CPI), a closely watched measure of inflation, rose sharply in January, driven by the biggest jump in energy prices since March 2003, when the U.S.-led war with Iraq began. In that month, markets reacted anxiously to the prospect of violence in the Middle East -- the bright, hot center of the world's oil supply.
Crude oil prices are also at their highest level since that time, toying with levels of about $35 a barrel since late January. And U.S. oil inventories are near their lowest level since late 2000/early 2001, when a recession was brewing.
Meanwhile, average gasoline prices were the highest on record in January, before adjusting for inflation, and the Energy Department said this week that inventories are likely to stay low, and prices high, through the summer driving season.
Despite the high prices and low inventories, the Organization of Petroleum Exporting Countries (OPEC), the cartel that controls more than one-third of the world's oil supply, pledged earlier this month to cut production, saying it expected demand for oil to fall in the spring.
Certainly, as the weather gets warmer, demand for home heating oil will fall, helping oil inventories rebuild and keeping a lid on prices. But some analysts doubt prices will fall as much as OPEC says they will -- in fact, prices could stay near their current level for months.
"We do anticipate some price moderation in the coming months, but only moderation that results in prices that are still high by just about anybody's definition," said James Burkhard, director of Cambridge Energy Research Associates, an energy consulting firm in Boston.
"The typical U.S. consumer may not see much of a difference when they go to the pump," Burkhard added.
The impact on consumers
And that, from a macroeconomic perspective, is the critical point.
Most economists believe higher energy prices act as a tax on the consumer, slowing down the spending that fuels more than two-thirds of the total economy.
"We notice it every day -- when we go to gasoline stations, we pay more," said Sung Won Sohn, chief economist at Wells Fargo. "And the higher cost of energy percolates throughout the economy eventually" by raising production costs for most businesses.
Consumers will enjoy the benefits of lower federal income tax rates in the first half of the year, along with tax refund checks that are expected to be larger, on average, than a year ago.
Economists have been hoping that lower tax rates and bigger refund checks will send consumers to the malls in droves, helping support growth in the first half. But some of that money could simply go to paying off the winter's high home heating oil bills or gassing up the SUV for a summer vacation.
"We are convinced that a large portion of the tax refunds that are scheduled to arrive in consumers' mailboxes in March and April will be dedicated to these exorbitant energy costs," said Richard Yamarone, chief economist at Argus Research. "With that, there'll be less money spent on other goods and services."
Most economists expect the positive effects of tax cuts to fade in the second half of the year. If oil prices are still high then, the economy could feel even more pain.
"The consumer is already somewhat vulnerable in the year ahead as the tax-cut effects fade," said Lehman Brothers chief economist Ethan Harris. "If we continue to see pressure from energy prices, consumer spending is almost sure to slow down some."
Prices not recessionary
Still, Harris said, the prospects for an oil-shock-driven recession -- which hit the economy back in the 1970s and early 1980s -- are slim.
Energy costs make up about 7 percent of a typical household budget, Harris said, and have risen about 7.8 percent in the past year, according to Friday's Labor Department report.
If that rate continues in 2004, it could curb the annual rate of consumer-spending growth by about a half-percentage point, according to Harris' estimate. Some economists believe consumer spending will grow about 3 percent this year -- shaving a half-percentage point from that rate won't be helpful to the economy, but it won't exactly be recessionary, either.
"In the big oil shocks that really damaged the economy, the tax on the consumer was many times more than that, but that alone wasn't enough," Harris said. "You also had to have people worrying that prices were going higher forever."
Of course, if by the second half of the year, job and wage growth are still as anemic as they have been in recent months, then high energy prices could conspire to slow consumer spending down even more.
"If we create [millions of] jobs, as the White House says we will, then real incomes will rise and we can afford to pay for the higher price of energy," said Sohn of Wells Fargo. "If not, it might be a problem."