Inflation cools off

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NEW YORK (CNNMoney.com) -- A smaller rise in energy prices resulted in a slower increase in overall prices in September, according to a government report Thursday.

The Consumer Price Index, the government's key inflation measure, is now down 1.3% over the past 12 months, driven by a 30% drop in the price of gasoline and a 2.5% drop in food prices during that time.

So-called core CPI -- which strips out food and energy prices -- is up 1.5% during the same period.

For September, prices rose 0.2%, down from the 0.4% rise posted in August. The increase was in line with forecasts of economists surveyed by Briefing.com. Core CPI for the month rose 0.2%. That increase was up from only a 0.1% rise in both July and August. Economists had forecast another 0.1% increase.

The drop in prices means that 57 million Americans who get Social Security benefits will not receive a rise in their benefits next year. This is the first time there will not be an increase since automatic adjustments for cost of living were put in place in 1975.

Social Security benefits increased by 5.8% in 2009, due to the large spike in gasoline prices recorded in 2008. That was the largest increase since 1982.

The lower prices are generally seen as another result of the severe recession, as job losses and reduced hours cut the money consumers had to spend, which in turn forced businesses to cut their prices.

Even though there is growing consensus that the recession ended earlier this year, the recovery has yet to lead to a significant increase in income or spending needed to raise prices once again.

Deflation fears: Beyond the impact on Social Security benefits, lower prices raise concerns among economists about the risk of deflation.

Deflation can cause the economy to slow further. If businesses expect prices to fall, they may cut production, which in turn leads to more job losses and even lower prices in the future

But economists generally watch core prices more closely than the overall prices, which can be affected by wide swings in food and energy prices.

The 12-month rise in core CPI is seen as in the middle of the 1% to 2% range generally seen as the Federal Reserve's target for that reading.

"This is a Goldilocks number that was not too hot for inflation hawks and not too cold for those worried about deflation," said Robert Dye, senior economist with PNC.

Future inflation risk: Over the past year, the Fed has cut its key interest rate to nearly 0% and injected more than $1 trillion into the economy through the purchases of securities backed by mortgages and other consumer loans. It has also increased purchases of U.S. Treasurys.

Some economists are worried that the Fed will have to move quickly to unwind those efforts to avoid inflation. But economists said Thursday that they don't think there's anything in the latest report to move the Fed in that direction.

"With inflation still well behaved, the Federal Reserve will be in no rush to increase rates," said Bernard Baumohl, chief global economist for the Economic Outlook Group. "Our forecast calls for the Fed to begin lifting the Fed Funds rate by next fall."