Drop in clothing prices key in lowering inflation

WASHINGTON — Gasoline prices soared last month. Airline ticket prices were also up sharply, and so was the price of a hotel room.

But clothing prices plunged by the largest amount in 18 years, and that decline helped lift spirits on Wall Street.

Stock prices surged for a second straight day Wednesday on better-than-expected news concerning core inflation, which excludes energy and food.

Core consumer prices rose by 0.2 percent, the smallest increase in five months, the Labor Department reported one day after disclosing that core inflation at the wholesale level actually fell 0.3 percent.

A big 1.4 percent drop in clothing prices was a major contributing factor to lowering core inflation to 0.2 percent, after four straight months of more worrisome 0.3 percent increases.

In a surprise to almost no one, the federal Bureau of Labor Statistics reported Wednesday that Seattle-area gasoline prices were 23.3 percent higher last month compared with July 2005, though gas prices did slip 2.9 percent compared with June.

The agency won't report full inflation data for the Seattle area until next month, but did release partial numbers for food, energy and shelter.

Household fuels rose 1.8 percent from June to July, and stood 7.6 percent higher than in July 2005. The grocery index rose 0.5 percent over June and 2.7 percent over the previous 12 months.

The shelter index, which includes both owned and rented residences, rose 1.2 percent in July and stood 6.1 percent above the July 2005 level.

Nationally, energy prices posted another big increase last month, jumping 2.9 percent, led by a 5.3 percent increase in gasoline prices.

So far this year, energy prices have risen at an annual rate of 25.3 percent, helping to boost overall inflation to an annual rate of 4.8 percent, compared with a 3.4 percent rise for consumer prices for all of 2005.

Crude-oil prices hit a new record above $77 per barrel in mid-July and markets continued to be roiled by Middle East tensions and tight supplies. Motorists are feeling the pain at the pump with gasoline climbing last week to a nationwide record of $3.03 per gallon, according to the Lundberg Survey.

Food costs slowed to a 0.2 percent increase last month, reflecting declines in the cost of beef, poultry and vegetables.

Outside of food and energy, new-car prices edged up just 0.1 percent, reflecting a new round of discounting by automakers trying to clear unsold cars, while airline fares jumped by 1.3 percent as airlines sought to pass on higher fuel costs, and the price of a hotel room increased by 0.6 percent.

Falling behind

American workers fell further behind to rising prices as average weekly wages, after adjusting for inflation, fell 0.1 percent, the fourth decline in the past seven months.

And investors, who have had the inflation jitters for months, seized on a second day of good inflation news to drive the Dow Jones industrial average to its best close in three months. The Dow rose 96.86 points Wednesday to close at 11,327.12, capping two days when the Dow gained nearly 229 points.

Two other reports Wednesday added to the view that a slowing economy could help to hold inflation in check.

The Federal Reserve reported that industrial production rose 0.4 percent last month, just half the June gain, as manufacturing output slowed dramatically, reflecting the continued woes of U.S. automakers.

And the Commerce Department said new-home construction dropped by 2.5 percent in July. It was the fifth decline in the past six months and pushed construction to a seasonally adjusted annual rate of 1.795 million units, the slowest pace since November 2004.

Building permits, considered a good barometer of future activity, dropped by 6.5 percent, a further sign that the five-year housing boom is over.

Fed speculation

Wall Street saw the combination of lower core inflation and a slowing economy as a sign that the Federal Reserve will not raise rates for an 18th time when the Fed meets again Sept. 20.

But private economists said investors may be overreacting. Some predicted the Fed would raise rates at least once more this year in response to core inflation that has risen 2.7 percent over the past 12 months, higher than the Fed's 1 percent to 2 percent comfort zone.

"The economy, while cooling off, is not cooling off quickly enough to lower inflation pressures and satisfy the Fed," said David Wyss, chief economist at Standard & Poor's in New York, who predicted one more Fed rate increase.

Richard Fisher, president of the Dallas Federal Reserve bank, said Wednesday that the Fed's next move remains an open question.

"If anybody tells you with absolute conviction that the Fed is done raising interest rates or with equal conviction that they have only paused and will raise rates again starting in September or October, remind yourself that at best — and I am being generous here — they are only guessing," Fisher said in a speech in Dallas.

Fisher said the Fed "will not tolerate inflation. But that doesn't mean we need to take a sledgehammer to the economy."

The Fed last week left a key interest rate unchanged, breaking a two-year string of uninterrupted rate increases and raising hopes among investors that the central bank is about to end its credit tightening.

But key to that decision will be the performance of core inflation, which excludes food and energy. The Fed wants to determine whether the sizable increases in energy prices over the past two years are beginning to become a problem in other areas.

Seattle-area information provided by Seattle Times business reporter Drew DeSilver. Associated Press business reporter David Koenig in Dallas also contributed to this report.