Wholesale prices fall sharply

NEW YORK (CNNMoney.com) -- Prices paid at the wholesale level fell sharply in August, driven by drops in energy and food prices, according to the government's last inflation reading before a much anticipated meeting of the Federal Reserve.

Overall, the Producer Price Index showed a 1.4 percent decrease in August, compared to the 0.6 percent rise in July. Economists surveyed by Briefing.com had forecast only a 0.3 percent decline in overall prices paid by businesses.

Wholesale prices posted their largest drop since October on lower energy and food prices.

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Overall energy prices fell 6.6 percent in the latest report, while food prices declined 0.2 percent. Together they helped lead the overall price measure to its biggest drop since October.

But energy prices, which fell in August, have rebounded since then. Crude oil futures for October delivery hit a record high close Monday and an intra-day record high early Tuesday, although prices at the gas pump have yet to follow oil futures higher.

The more closely watched core PPI, which strips out volatile food and energy prices, rose 0.2 percent. That was a bigger jump than forecast of economists, who had been looking for that measure to show the same modest 0.1 percent rise seen in July.

Turmoil in the financial markets has most investors and economists expecting the Fed to cut interest rates for the first time since June 2003. But the Fed has been reluctant to cut rates before now because of what it has seen as the risk of inflation.

The Fed is generally believed to want to see core inflation measures up between 1 and 2 percent on a year-over-year basis. The August report left the core PPI up 2.2 percent from a year ago, which while it was higher than the comfort zone, was down from the 2.3 percent rise in that measure a month earlier.

The real debate heading into the Fed meeting is whether it will make a quarter percentage point cut, also known as 25 basis points, or a half-point cut, also known as 50 basis points. Many believe markets will react negatively to only a 25 basis point cut at this meeting.

The PPI report also comes the day before the Consumer Price Index, the government's key inflation measure that follows retail prices. Economists forecast that the overall CPI was unchanged in August after a 0.1 percent rise in July, while core CPI rose 0.2 percent, the same increase seen in July.

While the public will not see CPI until Wednesday, the Fed policymakers will see that report at their meeting Tuesday.

Some economists said they doubt either report will tip the decision on Fed rates one way or another, even if the PPI is getting a lot of attention ahead of the 2:15 p.m. ET announcement.

"It was a pretty benign report," said Bill Cheney, chief economist for John Hancock. "I think on the inflation front, the Fed already had a green light to cut rates. Yes this confirms it, but whether it's 25 or 50, I find it hard to believe that one month's report would make that much difference to them."

But Rich Yamarone, director of economic research at Argus Research, said he believes there's enough inflation pressure in the pipeline that he doesn't believe the Fed should be cutting rates, even with the PPI report for August, given what has happened with crude oil futures since then.

"Sure, last month was good, but that report is in the rear view mirror and inflation is closer than it appears," he said. "We're very far from out of the woods on inflation."