Steep decline in consumer prices; deflation fears rise

In new signs the struggling economy continues to slow, the Federal Reserve revealed Wednesday that it has sharply lowered its projections for economic activity this year and next, and the Labor Department reported that U.S. consumer prices tumbled by a record amount in October, carried lower by skidding energy and transportation prices and new-home construction that continued to fall.

The swelling mass of bleak economic conditions seemed to go critical on Wednesday, as fears of deflation and the auto industry's waning prospects for a bailout drove financial markets into a late-afternoon frenzy of selling, sending the Dow Jones industrial average below the 8,000 mark to its worst levels in five years.

Financial companies led the charge, signaling that their problems persist despite billions in federal bailout funds. Investors looking for a bottom saw nothing beneath them but more room to fall.

Economic forecast

Minutes of its Oct. 28-29 meetings showed that the Fed approved a new economic forecast projecting that the economy, as measured by the gross domestic product (GDP), will be flat or show growth of just 0.3 percent for this year. GDP will either decline by a slight 0.2 percent or expand by 1.1 percent next year.

Those forecasts were both lower than the Fed's forecasts delivered to Congress in July.

The Consumer Price Index, a key measure of how much Americans have to spend on groceries, clothing, entertainment and other goods and services, fell by 1 percent last month compared with prices in the previous month, the Labor Department said Wednesday.

It was the steepest single-month drop in the 61-year history of the pricing survey.

"It's funny that just a few months ago everyone was wringing their hands over inflation," said Nariman Behravesh, chief economist at Global Insight. "It's gone. It's over."

Energy prices led the decline, falling 8.6 percent last month as the price of gasoline continued its steady slide from highs of more than $4 a gallon. The costs of transportation fell 5.4 percent while clothing prices fell 1 percent.

Oil prices

Oil fell 77 cents to settle at $53.62 a barrel on the New York Mercantile Exchange, about where prices were in January 2007.

"The dominant and common factor is the plunge in gasoline prices, which drove the bulk of the weakness," said James O'Sullivan, U.S. economist at UBS. "You're going to see huge declines in a month's time in the November reports. That's the biggest part of the weakness."

A report on the beleaguered real-estate market showed that housing starts fell 4.5 percent in October, to a seasonally adjusted 791,000. Housing starts last month were 38 percent lower than their October 2007 levels.

Economists said the tumbling consumer prices offered more evidence that companies ranging from boutiques to airlines to car dealerships were beginning to offer deep discounts to compete for a shrinking pool of disposable cash.

Spending tightened

Americans have tightened their spending as job losses rose and easy credit dried up.

"We're looking at a pretty deep recession now," Behravesh said. "All of a sudden, any pricing power that companies might have had is gone. You're going to see discounting like crazy going on. All kinds of sales. You're going to see all kinds of prices being slashed."

With consumers pulling back, many analysts are expecting a difficult Christmas shopping season. Retail sales, for example, were down 2.8 percent in October from September, and 4.1 percent from October 2007 as consumers pared their spending.

In Wednesday's report, even excluding volatile food and energy prices, prices dropped 0.1 percent last month. It was the first such decline in more than two decades and raises the specter of deflation as the economy contracts and demand for goods and services across the board plunges.

"This month it's more than slowing, it's outright contraction," O'Sullivan said. "And yes, if you extrapolate that, it's deflation."

O'Sullivan added that he expects core prices, which are up 2.1 percent this year, to continue to fall back.

The price of food and beverages edged up last month and was still 6.1 percent higher than the same period last year.

And while energy prices fell sharply in October, they were still an unadjusted 11.7 percent higher than a year ago, thanks to a long run-up in oil costs.

Information from The Associated Press is included in this report.