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NEW YORK (CNN/Money) -
Prices paid by businesses tumbled last month due to the biggest drop in oil prices in two years, the government said Tuesday in a report showing lower inflationary pressures than economists had expected.
The Labor Department said its Producer Price Index, a measure of inflation on the wholesale level, sank 0.6 percent in May after rising 0.6 percent in April. Economists surveyed by Briefing.com forecast that the PPI would fall 0.2 percent.
Energy prices fell 3.5 percent during the month, the department said, accounting for about three quarters of the decline in the PPI. Food prices also fell, down 0.3 percent during the month.
It was the sharpest drop in oil prices since April 2003, when energy prices tumbled 7.2 percent after three months of sharp increases ahead of the war in Iraq. The 0.6 percent fall in the overall PPI was also the biggest percentage drop since April 2003.
The so-called core PPI, which excludes often volatile food and energy costs, rose 0.1 percent after a 0.3 percent gain in April -- the third month in the last four that the core reading rose 0.1 percent. . Economists had forecast a 0.2 percent increase.
Investors and economists have been looking for clues about whether the Federal Reserve might soon pause or halt its quarter-point interest rate hikes.
Wall Street showed scant reaction to the report, as well as a separate report showing weaker-than-expected retail sales. Stocks traded little changed and Treasury bond prices drifted lower.
Consumer prices up next
Tuesday's report comes a day ahead of the Consumer Price Index, which measures prices at the retail level. Economists surveyed forecast that CPI rose 0.1 percent in May after a 0.5 percent increase in April, while the core rate is seen up 0.2 percent after being little changed the previous month.
"The Fed is watching consumer prices, they're not watching producer" prices, said Drew Matus, economist with Lehman Brothers. "The trends are that there could be some upside surprise in consumer prices, even with producer prices retreating."
Matus said the greater importance of the CPI is one reason the markets didn't move more on the PPI report.
"We really need to get through tomorrow, and not only look at CPI, but the Beige Book for the anecdotal information the Fed is receiving on prices," he said.
The so-called Beige Book, the Fed's periodic report on business conditions from the central bank's 12 regional banks, is due Wednesday afternoon.
The current focus on inflation in a period of modest price increases is somewhat unusual, said Tom Schlesinger, executive director of Financial Markets Center, an economic research group. He also pointed to recent Beige Book comments about businesses reportedly having more pricing power.
"Certainly the Fed has voiced more concern over inflation for public consumption that it has in previous years, so it's not surprising that markets would respond accordingly," said Schlesinger. "It just really doesn't jive very well with the facts on the ground."
Schlesinger said that while there is greater attention being given to inflation reports, low long-term rates in the Treasury market are a sign that investors don't believe inflation's a significant threat, or that they believe that economic growth will slow down.
"The yields indicate that markets aren't concerned about inflation or that they're confident that the Fed is on the job and will contain it," said Schlesinger. "But there's some sort of subconscious, collective belief that sustained manageable inflation is too good to be true and eventually the other shoe will drop."
For a closer look at the Federal Reserve and the central bank's current thinking, click here.
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