Consumer prices drop while factory output surges

WASHINGTON -- Consumer prices in May posted the 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.

The Federal Reserve released a new nationwide survey of business conditions that described the economy as expanding at a healthy pace in recent weeks, with the Fed's 12 regional banks describing activity with such words as "moderate," "solid" and "well sustained."

The Fed report, which will serve as the basis for discussions when policy-makers meet June 29 and 30, said manufacturing had continued to expand with labor markets improving in most districts.

But private analysts cautioned that the economy remained vulnerable to further oil price increases 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, an economic forecasting firm.

The Labor Department reported that its Consumer Price Index fell by 0.1 percent in May following significant increases in the previous three months that had been driven by a rise in energy costs. Crude oil prices hit an all-time high of over $57 per barrel in early April.

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

Meanwhile, production at the nation's factories, mines and utilities rose by 0.4 percent, double the gain analysts had expected. It reversed a 0.3 percent drop in industrial production in April and reflected a surge of 0.6 percent in output at American factories.

The overall gain in industrial production was led by a 0.6 percent increase in manufacturing output, which was the strongest performance in this sector in seven months and came after two back-to-back declines had raised worries about whether U.S. manufacturing, the hardest hit part of the economy in the 2001 recession, was once again faltering.

The 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 the central bank's current course of raising interest rates gradually to make sure inflation remains contained.

They predicted a ninth quarter-point rate hike on June 30, which would push the federal funds rate to 3.25 percent. When the Fed started tightening credit a year ago, the funds rate was at a 46-year low of 1 percent.

So far this year, inflation has been rising at an annual rate of 3.7 percent, up slightly from the 3.3 percent increase for all of 2004 as energy prices have pushed ahead at an annual rate of 18.7 percent, up from a 16.6 percent rise for all of 2004.

Outside of food and energy, inflation has generally been well-behaved, rising by a tiny 0.1 percent in May and at an annual rate of 2.4 percent so far this year, only slightly higher than last year's 2.2 percent increase.

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

OPEC agreed Wednesday at a meeting in Vienna to increase its production quota by a half million barrels a day as of July 1, but oil traders worried about disappointing inventory data from the Department of Energy.

The CPI report showed that food prices moderated last month, posting a tiny 0.1 percent increase after a 0.6 percent surge in April, which had reflected a big jump in the price of soft drinks and snack products.

Outside of food and energy, clothing costs were unchanged after having fallen by 0.6 percent in April. Clothing prices are being restrained by a big surge in Chinese imports reflecting the elimination of a global quota system.

New car costs edged up a slight 0.1 percent in May while airline ticket prices shot up 2.2 percent as airline companies sought to pass on higher fuel costs to their passengers.

The moderation in overall inflation helped to boost the real incomes of American workers. Average weekly pay of nonsupervisory employees, after adjusting for inflation, rose by 0.3 percent in May after three straight monthly declines.

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On the Net:

Consumer prices: http://www.bls.gov/cpi

Industrial production: http://www.federalreserve.gov