WASHINGTON -- A huge drop in tobacco prices caused the government's producer price index to plunge unexpectedly in August, bolstering analysts' expectations of stable inflation throughout the remainder of the year.
The Labor Department said the price index dropped a seasonally-adjusted 0.6% last month, while the core index, excluding food and energy prices, fell an even steeper 1.0%.
August marked the biggest drop in the producer price index in two and a half years and the largest decline in the core price index since it was first calculated during the energy crisis of the early 1970s. The index's decline was the fourth straight monthly drop after decreases of 0.2% in July, 0.3% in June, and 0.1% in May.
"We're looking at a stable inflation picture at least through the end of this year." said David Jones, chief economist of Aubrey G. Lanston & Co.
The Labor Department noted, however, that that a 26% drop in wholesale tobacco prices single-handedly caused the producer price measures to fall. Excluding tobacco, the index would have gained 0.2% in August, which is what economists had anticipated. Tobacco producers have been talking about slashing prices for several months.
Regardless of the drop in tobacco prices, the year-over-year producer price indices have been drifting downward since April. Compared to a year ago, the producer price index in August was up 0.6% and the index was up 0.7%, the department said.
"This report is not as good as it looks, but it still is very good," said Stuart Hoffman, chief economist of PNC Bank Corp. in Pittsburgh.
The index measures prices of finished goods that will not undergo further processing. Also in August, intermediate goods prices were unchanged and crude goods prices fell 0.5%, which was the third straight decline, the department reported.
Friday's surprising producer price report prompted some economists to revise down their forecasts for consumer price index inflation in August, due out tomorrow.
Gary Ciminero, chief economist of the Fleet Financial Group in Providence, R.I., said he shaved 0.1 percentage point from his forecasts for the August consumer price index and the core index. He said he now expects a 0.1% gain in the overall CPI and a 0.2% increase in the core CPI.
"Inflation isn't about to leap forward," Ciminero said. "Much of this has to do with the total lack of pricing power on the part of businesses --consumers are very reluctant to spend."
At least part of that drastic drop in tobacco prices will show up in the August consumer price index report, Hoffman said. He predicted that both the consumer price index and the core consumer price index will be unchanged in August. In the three months ended in July, the consumer price index was up only 0.8%, the smallest three-month gain in seven years.
In general, economists say the underlying inflation rate on the consumer level is around 3% and around 2% on the producer level. Yet a few analysts say this year still has a chance of beating last year's six-year low inflation rate of 2.9% on the consumer level.
Hoffman forecast a 2.8% gain in the year-over-year consumer price index at the end of this year. "We still have an excellent chance of beating 1992," he said, citing a very slack world economy, failing oil prices, and further gains in U.S. productivity, which he predicts.
Several economists predicted slightly stronger growth in the second half of the year. Jones predicted real growth averaging about 2.5% in the third and fourth quarters. Hoffman's forecast was slightly higher.
Analysts said growth could pick up modestly without sparking an immediate upward trend in inflation. "We have sustainable moderate growth, steady inflation, and a stable Federal Reserve," Jones said.
Jones and other analysts predicted that the Federal Reserve Board would not raise short-term interest rates as long as inflation appears to be under control, and that should last at least through the remaining months of this year. "I don't foresee the Fed raising the fed funds rate this year," Hoffman said.
Economists also ruled out any possibility of the Fed's easing rates. "I don't think they'd budge on the downside," Ciminero said.
