While this week brought some pretty frightening numbers on industrial production and manufacturing surveys, I viewed Friday’s CPI release from the Bureau of Labor Statistics as slightly encouraging.

The BLS reported Friday that the seasonally adjusted consumer price index rose by 0.3% between December and January, implying a 3.4% annual inflation rate. For those of us who had been worried about deflation, that offers some reassurance that things may not be quite as desperate as we feared.

Some reassurance, I say, but not a whole lot. The January number still leaves the headline CPI down 2.2% from October, implying an annual deflation rate over the last three months of -8.7%. The year-over-year percent change in the seasonally unadjusted CPI has continued to drop, with the January 2008 to January 2009 change barely positive.

If we leave out food and energy, the January increase (+0.2% monthly) is enough to erase the deflationary signals for October and December.

Even so, the year-over-year core inflation rate continues to decline through the latest reading:

The gap between nominal Treasury securities and those whose coupon and principal are indexed to the headline CPI had vanished or even turned negative in November and December, perhaps reflecting significant deflationary concerns. That gap has since widened, suggesting bond-holders see deflation as less likely today than they did a few months ago.

Here’s why I think this is worth watching. There’s been some interesting discussion as to how we would objectively measure whether the stimulus plan will be beneficial. The core motivation for policy stimulus is the perceived need to increase aggregate nominal spending. Some have claimed that with the nominal T-bill rate near zero, monetary policy is no longer capable of providing such a stimulus. I disagree with that assessment, though I can understand that it is a very legitimate position to take. But if we do get back up to a year-over-year 3% inflation rate, I would think that an objective observer would want to agree at that point that we’ve achieved all we can hope for with the tool of demand stimulus. I continue to recommend that the Federal Reserve think of achieving that 3% inflation rate as their primary policy objective at the moment.

We’re not there yet.