Inflation on the ropes

NEW YORK (CNNMoney.com) -- Consumer prices fell in October, led by a drop in gasoline prices, the government said Thursday in a report that showed other prices little changed, raising hopes on Wall Street that inflation pressures are in retreat.

The Consumer Price Index, the government's main measure of inflation at the retail level, is the second positive report on prices this week. On Tuesday, the Producer Price Index showed the biggest drop since 1993 in a key measure of inflation at the wholesale level.

Inflation adjuster How much would: $ in: be worth today? Today's dollars: $

Thursday's CPI report showed overall prices sank 0.5 percent from September, matching the 0.5 percent fall seen that month. Economists surveyed by Briefing.com had forecast a 0.3 percent drop in prices in the CPI.

Energy prices plunged 7 percent last month, led by an 11.1 percent drop in the price of gasoline.

The so called core CPI, which strips out volatile food and energy prices, edged up 0.1 percent, following a 0.2 percent gain posted in September. Economists had forecast another 0.2 percent increase in core prices.

Even some economists who are "inflation hawks" who have been voicing greater concerns about price pressures admitted Thursday's report was a positive sign on inflation.

"This is a very encouraging report. But it's only one report," said Rich Yamarone, director of economic research at Argus Research.

It was the smallest monthly rise in core CPI since February, and it put the core CPI up 2.7 percent on a year-over-year basis. That's down from the 2.9 percent year-over-year gain in the September report, which had been the biggest 12-month increase in more than a decade.

That annual change is closely watched by those trying to determine what the Federal Reserve will do to interest rates in order to battle inflation. While 2.7 percent is a bit above what economists say is the comfort zone for the Fed, there had been a fear that an upside surprise in the core CPI could have taken the year-over-year change to 3.0 or more, which could have brought talk of a new round of rate hikes to battle inflation.

Wednesday, the release of the minutes of the Oct. 24 and 25 meeting of Fed policymakers showed they were still very worried about inflation, giving rise to concerns that the Fed could leave rates unchanged throughout 2007 rather than cutting rates in the face of slower economic growth, as many investors had hoped.

Jeoff Hall, the chief U.S. economist for Thomson Financial, said he doesn't think even the positive numbers in Thursday's CPI report was enough to open the door to Fed rate cuts.

"It's too early to call inflation dead," he said. "We're encouraged by it. I think we've hit a bottom on energy prices, so once those effects are removed, you could see an increase in inflation. So while I don't think inflation is a a pressing enough concern for the Fed to be hiking rates, it doesn't provide cover for them to be cutting."

The modest gain in the core CPI was due greatly to how the Labor Department measures housing costs, which is pegged more to rents than it is to home prices.

Because of increased rents the government's key home price measure is up 4.1 percent compared a year ago, the biggest rise since 2002, even as a weakening housing market has been sending home prices lower.

"I personally wish they would go to European definition of core inflation, which also excludes owner occupied housing," said David Wyss, chief economist for Standard & Poor's. "For 69 percent of the population that owns a home, that owner occupied rent has nothing to do with what you spend every month."

If the questionable home price figures in the CPI report were also excluded from core CPI then the closely watched measure would have shown no inflation in October.

But Yamarone said that the report shows some key commodity prices increasing. He's also concerned that some businesses are announcing price hikes, which suggests to him a stronger economy than many economists are projecting. He sees more inflation pressure than can be seen at first blush in Thursday's number.

"I'm worried about prices for things like corn, which are escalating," he said. "You might not think that matters but that translates into prices for animal feed, corn syrup, a wide variety of products. So it means American consumers are going to be paying a lot more for food down the road. We're not out of the woods by a long stretch."

But other economists argued the Thursday report shows a level of inflation that both they and the Fed can live with.

"Every month, the core CPI is right around the 0.2 percent level," said Wachovia chief economist John Silvia. "That's probably acceptable."

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