Wholesale Prices Fall an Unexpected 0.6% During August : Economy: Cost cutting in tobacco products leads to the steepest monthly drop in the producer price index in 2 1/2 years.

A sharp drop in the price of tobacco products pushed wholesale prices down a surprising 0.6% in August, the government said Friday.

It was the fourth straight monthly decline in the producer price index and the biggest one-month drop in 2 1/2 years, the Labor Department said. “Inflation just went up in smoke last month,” quipped Ron Schreibman, vice president of the National Assn. of Wholesaler-Distributors in Washington.

Analysts had been expecting inflation to rise slightly last month because the index had dropped in the three previous months.

But a record 25.6% plunge in the price of tobacco products--triggered by a round of price cutting by big cigarette manufacturers about two months ago--easily offset a modest 0.5% rise in the cost of food.

Excluding tobacco, wholesale prices actually increased 0.2% last month--about what analysts were expecting.

The report “was good news for consumers because inflation remains in check, and especially good news if you’re a consumer who smokes,” said Cynthia Latta, a senior economist for DRI/McGraw Hill in Boston.

Energy prices fell 0.8% in August, the fourth decline in a row. Excluding volatile food and energy prices, the so-called core rate of the index fell a record 1.0%.

The producer price index measures inflation trends at the wholesale level and is considered a good indicator of which way prices will move when the goods eventually hit store shelves.

The good news on inflation contained in Friday’s report should also discourage the Federal Reserve Board from raising interest rates when it meets Sept. 21.

In July, Fed Chairman Alan Greenspan warned Congress that sooner or later the central bank would have to begin pushing rates higher to dampen inflationary pressures. But since that time, prices at both the wholesale and retail level have been dropping after a brief run-up earlier in the year.

Schreibman at the wholesalers group said inflation should remain in check over the next few months, saying further declines in energy prices should offset likely food price increases caused by the summer flooding in the Midwest.

Kevin Flanagan, an economist at Dean Witter Reynolds in New York, agreed that inflation should remain low through the rest of the year. He noted that prices for raw goods--the materials that manufacturers and other producers use to make their goods--dipped 0.5% in August.

“There’s nothing coming down the pike as far as price hikes are concerned,” Flanagan said.