U.S. Producer Price Index Drops More Than Forecast (Update2)

By Courtney Schlisserman

Sept. 18 (Bloomberg) -- Prices paid to U.S. producers fell more than forecast in August, diminishing concern over inflation as the Federal Reserve considers lowering interest rates.

The 1.4 percent decrease, the biggest since October, followed a 0.6 percent increase in July, the Labor Department said today in Washington. So-called core prices, which exclude fuel and food costs, rose 0.2 percent after a 0.1 percent gain the month before.

Slower inflation gives policy makers more room to reduce their benchmark rate later today in an effort to sustain the expansion in the face of a housing recession. A drop in fuel expenses pushed prices down in August and slacker economic growth will continue to restrain raw-material costs in coming months, economists said.

The Fed ``can point to reasonably good news on inflation,'' said Peter Kretzmer, a senior economist at Banc of America Securities LLC in New York, who accurately forecast the core rate. ``The weakness in the economy is making it difficult for companies to pass along increases. That bodes very well'' for inflation in coming months, he said.

The yield on U.S. Treasury securities was little changed following the report as investors waited for the results of the Fed meeting later this afternoon. The yield on the benchmark 10- year note was 4.48 percent at 8:43 a.m., compared with 4.47 percent late yesterday.

Economists forecast producer prices would decline 0.3 percent after a 0.6 percent increase, according to the median of 76 projections in a Bloomberg News survey. Estimates ranged from a drop of 1.2 percent to a gain of 0.5 percent.

Core prices were expected to rise 0.1 percent.

Prices Ease

Over the past 12 months, producer prices rose 2.2 percent, down from a 4 percent increase in July. The year-over-year increase in costs excluding food and energy also eased to 2.2 percent compared with 2.3 percent in July.

Economists almost universally forecast the Fed will cut the benchmark overnight lending rate between banks for the first time since 2003. The median calls for a quarter-point cut to 5 percent. The central bank typically makes its announcement around 2:15 p.m. in Washington.

The drop in wholesale prices last month was led by a 6.6 percent decline in energy costs that was the biggest since April 2003. Costs for gasoline, natural gas, heating oil and diesel fuel all fell.

Costs of intermediate goods, such as steel used in earlier stages of production, fell 1.2 percent in August, after a 0.6 percent increase the prior month. They were up 2.4 percent from a year ago.

Costs Fell

Excluding food and energy, intermediate prices fell 0.5 percent and were up 2.4 percent from August 2006.

Prices for raw materials, or so-called crude goods, dropped 3 percent.

The cost of consumer goods fell 1.8 percent as food charges fell and prices for capital goods rose 0.1 percent.

The producer-price report is the second of three monthly inflation gauges. The government said on Sept. 14 that import prices dropped 0.3 percent in August, the first decline in seven months. Results for consumer prices will be issued tomorrow.

The Fed cut the interest rate on loans to banks on Aug. 17 as global stock markets slumped on concern damage from rising mortgage defaults was spreading. At the time, policy makers dropped language indicating their bias toward fighting inflation and instead highlighted a rising threat to economic growth.

`Downside' Growth Risk

``The Federal Reserve must remain vigilant on inflation but give appropriate attention to keeping demand from falling below supply as well,'' Fed Governor Frederic Mishkin said last week. ``The risks to the inflation outlook have become more balanced, given the greater downside risks to real growth.''

The Fed's preferred inflation measure has shown signs of easing. Prices tied to spending and excluding food and energy costs were up 1.9 percent from a year earlier in July, matching June's increase, the Commerce Department said on Aug. 31. That put the measure within the comfort zone of 1 percent to 2 percent cited by several policy makers, including Fed Chairman Ben S. Bernanke.

``Because the trend in inflation is towards moderation, the risks on the growth side dominate,'' Meny Grauman, an economist at Scotia Capital in Toronto, said before the report.

Faced with the prospect of an economic slowdown, some companies are lowering prices to stoke demand ahead of the key holiday-spending season in the last three months of the year. Apple Inc. Chief Executive Officer Steve Jobs earlier this month cut the price of the iPhone by $200 to boost sales. The calendar fourth quarter and the back-to-school season that just ended are Apple's two busiest periods.

Price Increases

Others are suffering from increases in commodity costs and are boosting prices as a result.

``We've already raised prices and have more planned,'' Sara Lee Corp. Chief Executive Officer Brenda Barnes told analysts last week. ``We are certainly facing these headwinds of increased commodity costs, some of them at unprecedented levels, like wheat.''

Sara Lee fell $10 million short of covering the jump in raw-material costs, even after raising prices on bread and coffee, Barnes said.

Last Updated: September 18, 2007 09:01 EDT