Consumer Prices Show Sharp Drop

Big declines in the cost of gasoline and other types of energy last month fueled the largest drop in consumer prices in 15 years, the government announced Thursday, suggesting that inflation remains a distant threat.

Policymakers, businesspeople and investors have been looking for signs that the hard times might be coming to an end. The 0.3% drop in consumer prices, coupled with good news on rising housing starts and the falling rate of unemployment applications, gives some hope that the economy may have stabilized a bit.

The core inflation rate, which excludes often-volatile energy and food prices, rose 0.2% from June to July. Still, economists said the unexpectedly large dip in the Labor Department’s overall consumer price index gives the Federal Reserve plenty of room to again reduce interest rates next week without running much risk of overheating the economy.

“The signs of falling prices are beginning to spread,” said Brian S. Wesbury, chief economist with Griffin, Kubik, Stephens & Thompson, a Chicago investment bank. “We’re going to continue to see inflation stay very, very low.”

Federal Reserve officials are widely expected to lower interest rates by a quarter of a percentage point when they meet Tuesday to assess the state of the economy. The Fed already has cut rates six times for a total of 2.75% this year in an effort to keep the economy afloat, reducing the interest charged on overnight loans between banks to a seven-year low of 3.75%.

Chris Varvares, president of Macroeconomic Advisers in St. Louis, said he thinks a quarter-point cut next week is a slam-dunk, and a half-point rate reduction, though less likely, is not out of the question.

“The Fed doesn’t view inflation as a problem right now,” Varvares said. “It’s still focused on weakness on the real side of the economy.”

The stock market appeared nonplused by the positive price figures, trading down most of the day before rallying late in the session. The Dow Jones industrial average rose 46.57 to close at 10,392.52; the Nasdaq composite index climbed 11.43 to finish at 1,930.32.

In the five-county Southern California area, consumer prices also fell 0.3% in July, the first decline in seven months. Lower gasoline and natural gas costs were the main reason for the decline. Over the last 12 months, prices are up 3.8% in the area for all consumer goods. Excluding food and energy, prices over the 12-month period are up 2.9%.

The 0.3% monthly decline in the national CPI was the biggest since early 1986. It has fallen only twice since, in April 2000 and again in July.

Economists surveyed by Bloomberg News before Thursday’s report had expected a decline of 0.1% for July.

The bigger-than-expected drop was attributable mainly to falling energy prices. Gasoline dropped 11% for the month, residential natural gas 4%, and fuel oil 3%, offsetting to some extent the price spikes of late 2000 and early 2001. Electricity prices, however, continued to ratchet upward, particularly in California.

There were scattered declines outside the energy sector, with average prices dropping for computers, clothing, shoes, airline tickets, and hotels and motels, the Labor Department said.

“All of this is suggesting that even though unemployment is low, the slowdown in the economy is having a disinflationary effect,” said Jim Glassman, senior U.S. economist for J.P. Morgan & Co. in New York. “It’s the reason why the Fed has been able to move aggressively.”

So far this year, consumer prices have risen at an annual rate of 2.8%, compared with 3.4% last year. The index for energy prices, which registered double-digit increases in 1999 and 2000, has declined at an annual rate of 0.7% during the first seven months of 2001.

Analysts said the big decline in fossil fuel prices reflects several positive developments. Refineries have dealt with bottlenecks that contributed to higher pump prices. Summer temperatures have been moderate, allowing natural gas suppliers to replenish their reserves.

Nationwide, the average price of a gallon of unleaded gasoline was $1.48 in July, down from $1.64 the previous month. The average price in Southern California was $1.82, down from a high of $2 in May.

The cost of natural gas used in homes has posted equally dramatic declines, particularly when compared with highs reached earlier in the year. The average price of residential gas fell to $89 per 100 therms nationwide, from a January high of $112. In Southern California, gas cost $75 per 100 therms on average, down from $116 in March.

But electricity prices continued their inexorable rise, reaching a July average of 9.9 cents per kilowatt-hour nationwide, and 17.2 cents per kilowatt-hour in Los Angeles, Riverside and Orange counties. The figures reflect rate increases approved earlier this year in response to widespread power outages and wholesale price spikes.

The core inflation rate has increased at an annual rate of 2.9% so far this year, compared with 2.6% last year. The acceleration has been fueled in part by rising prices for shelter, medical care and tobacco products.

Richard Yamarone, chief economist with Argus Research Co. in New York, said those figures cause him to question the consensus view that rising prices pose no threat to the economy.

“There’s inflation in them thar hills, particularly in services,” Yamarone said. “That matters because we’re not a commodity-based, raw-goods, raw-material nation. We’re a nation of services.”

Because there is a long lag time between Fed rate cuts and their effect on prices, it is not clear whether the central bank has provided the right amount of monetary stimulus or tipped the scales toward inflation, Yamarone said.

The White House, for its part, clearly expects the economy to perk up soon. Presidential spokesman Ari Fleischer said Thursday that the White House will release a report next week projecting economic growth of 3.2% in 2002, up from an estimated 1.7% this year.

The projected growth will enable President Bush to pursue his budgetary goals without dipping into the Social Security surplus, Fleischer said.

Other economic indicators released Thursday suggested that a modest revival might be underway. The Commerce Department reported that construction of new homes rose 2.8% in July. The increase, to an annual rate of 1.67 million housing starts, was the biggest in 17 months.

In a separate report, the Labor Department said the number of workers filing new applications for unemployment benefits fell to 380,000 last week, down 8,000 from the week before.

Glassman said the combination of low unemployment and low inflation, which he expects to continue, is upending traditional assumptions within his profession about how the economy works.

“What we’re learning is that this increased globalization, and the deregulation we’re doing and the successful management of inflationary expectations by the Fed are all working together to let the U.S. operate at higher levels than we once thought possible,” he said. “We really don’t understand it. . . . But in my opinion, it’s a profound thing. It’s the reason the stock market is still very highly valued.”

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Times staff writer Stuart Silverstein contributed to this report.

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Consumer Price Index

Monthly percentage change, seasonally adjusted:

Source: Bureau of Labor Statistics