Consumer Prices Drop in May as Output at Factories Surges

Consumer prices in May posted their first decline in 10 months as energy costs staged a sizable retreat. At the same time, the pace of activity at U.S. factories jumped sharply.

A variety of reports released Wednesday depicted an economy shaking off the effects of an oil price surge in the early spring and resuming solid growth. But analysts cautioned that the economy remained vulnerable to further oil price hikes in the months ahead.

“We really have a tight energy market because demand is pressing up against the capacity to produce,” said Nigel Gault, chief U.S. economist for Global Insight Inc., an economic forecasting firm. “Where we would really be in trouble is if there is a terrorist attack or some sort of natural disaster that affected oil production.”

The Labor Department reported that its closely watched consumer price index fell 0.1% in May after significant increases in the previous three months that had been driven by surging energy costs. Crude oil prices hit an all-time high of more than $57 a barrel in early April.

But energy prices fell in May, led by a 4.4% drop in the price of gasoline, the biggest one-month decline in pump prices since July.

A separate report released by the Federal Reserve, the anecdotal “beige book” report prepared for the meeting of the central bank’s policymaking Federal Open Market Committee June 29-30, found the economy expanding with price pressures largely absent.

In the western U.S., the Federal Reserve Bank of San Francisco found “tight labor markets led to a slight increase in upward wage pressure.” Home prices in the region rose at an accelerated rate.

Meanwhile, production at the nation’s factories, mines and utilities rose 0.4%, double the gain analysts had expected. The increase reversed a 0.3% drop in industrial production in April and reflected a surge of 0.6% in output at U.S. factories.

The gain in factory output was the strongest performance in seven months and came after two back-to-back declines had raised worries about whether U.S. manufacturing, the hardest-hit sector in the 2001 recession, was once again faltering.

The overall manufacturing gain was led by strong increases in production of computers, electronics and food and beverages. Auto production, which had fallen sharply in March and April, held steady in May.

Economists said the Federal Reserve was likely to see the new economic data as providing support for its current course of raising interest rates gradually to make sure that inflation remained contained.

They predicted a ninth quarter-point rate hike June 30, which would push the Fed’s key short-term interest rate, the federal funds rate, to 3.25%. When the Fed started tightening credit a year ago, the rate was at a 46-year low of 1%.

This year, inflation has been running at an annual rate of 3.7%, up slightly from 3.3% for all of 2004, as energy prices have climbed at an annual rate of 18.7%, up from a 16.6% rise for all of 2004.

Outside of food and energy, inflation has generally been well-behaved, rising 0.1% in May and at an annual rate of 2.4% this year, only slightly higher than last year’s 2.2% increase.

The drop in consumer prices for May was the first decline since a 0.1% decrease in July 2004, a drop that also reflected a slide in energy costs. In May, energy prices fell 2% as the price of gasoline, home heating oil and natural gas were all down.