Producer prices fall off a cliff

The 2.8 percent drop reflects sharply lower fuel costs and could allow more Fed rate cuts

WASHINGTON -- Wholesale prices in October experienced the biggest one-month drop in records that go back more than 60 years, illustrating the impact falling energy prices and fears of a long recession can have on inflation.

Wholesale prices dropped by a record 2.8 percent last month, reflecting the fact that energy prices decreased by the largest amount in 22 years. After spending most of the year worrying about surging costs for energy, food and other commodities, analysts found it remarkable that prices could reverse so quickly.

"Inflation is yesterday's problem," said Nigel Gault, chief U.S. economist at IHS Global Insight. He called the change "a testament to how suddenly the global economy's expansion has turned into recession."

Economists said they did not think the country would experience outright deflation, which was last faced in the U.S. in the 1930s when the nation suffered through the Great Depression and a long, debilitating bout of falling prices.

"I think deflation concerns will rise over the next three to six months while the economy is at its worst and businesses are scrambling to hold on to sales by cutting prices," said Mark Zandi, chief economist at Moody's Economy.com. "But I don't think we will get an actual period of deflation, because the Federal Reserve will be working very hard to make sure that doesn't happen."

Interest rate effect

Many economists think the recession could be the worst downturn in more than two decades. But they think that retreating inflation pressures will give the Fed the room to cut interest rates further to combat the economic weakness.

The Fed cut interest rates by a half-point in a coordinated move with other central banks Oct. 8, when the financial market turmoil was growing in intensity, and followed with another half-point reduction Oct. 29.

The federal funds rate, the target rate for overnight loans between banks, is now at 1 percent, matching a low seen only once before in the past half-century. Many economists predict the Fed will cut the rate to 0.5 percent at its Dec. 16 meeting.

"We are facing a recession, and it is going to be a pretty bad one," said David Wyss, chief economist at Standard & Poor's in New York. "The Fed is going to keep doing all it can to support the economy."

The 2.8 percent drop in wholesale prices in October followed smaller declines of 0.9 percent in August and 0.4 percent in September. It was bigger than the 1.8 percent decline economists had been expecting and surpassed the old record fall for a single month, a decline of 1.6 percent in October 2001, the month after the terrorist attacks.

Energy declines

The report showed that energy prices dropped by 12.8 percent in October, the biggest one-month fall since a 14 percent decline in July 1986. That drop reflected the fact that crude oil prices have fallen by more than 60 percent since peaking at an all-time high of $147 per barrel in mid-July.

Core inflation, which excludes energy and food, showed a 0.4 percent increase in October; a 0.1 percent rise had been expected.

Analysts blamed much of that gain on a jump in prices for light trucks, a category that includes sport utility vehicles. It was not expected to be sustained, given that auto sales are declining as demand falters in the face of rising unemployment and falling consumer confidence.

All types of energy showed big declines, with gasoline falling by a record 24.9 percent, surpassing the old mark of a 22.1 percent drop in March 1986. Home heating oil prices were down 9.6 percent, natural gas intended for home uses fell by 5.9 percent, and liquefied petroleum gas dropped by 27.6 percent, the biggest decline in more than three decades.

Food costs edged down 0.2 percent last month, as declines in the price of milk and meats offset a big jump in vegetable prices.

Excluding food and energy, the 0.4 percent increase in core prices reflected not only higher costs for light trucks but also increases for tires, malt beverages such as beer, and civilian aircraft.