Tue Aug 17, 2004
By Tim Ahmann

WASHINGTON (Reuters) - U.S. consumer prices dropped in July for the first time in eight months as a sharp run up in energy costs reversed, the government said on Tuesday in a report showing inflation pressures largely in check.

A separate report showed groundbreaking for new homes posted their biggest gain in nearly two years last month, making up almost all the ground lost in a June slump.

The consumer price index, the most widely used gauge of U.S. inflation, slid 0.1 percent in July, the Labor Department said. It was the first decline since a 0.2 percent drop in November.

The so-called core CPI, which strips out volatile food and energy costs, inched up 0.1 percent as a big jump in lodging costs largely offset drops in prices for apparel, recreation and education and communication. New car prices also fell.

Economists had expected the CPI to rise 0.1 percent with the core rate up 0.2 percent.

The tame readings were warmly received on Wall Street as traders guessed the U.S. Federal Reserve would not need to push interest rates aggressively up to head off inflation. U.S. bond prices climbed, the dollar sagged and stock futures rallied.

Many in the markets had worried earlier this year when core prices accelerated that Fed policymakers were falling behind the inflation curve.

"The inflation scares earlier this year now seems to have corrected as the economy slows," said David Sloan, an economist at 4CAST Ltd. in New York. "This is quite an encouraging figure for the Fed."

The report showed energy costs plunged 1.9 percent last month after hefty gains of 2.6 percent in June and 4.6 percent in May. The July drop in energy prices more than offset a 0.3 percent gain in food prices.

FIRMER GROUND

Separately, the Commerce Department said housing starts rose a healthy 8.3 percent to an annual rate of 1.978 million units in July, the biggest gain since September 2002.

Analysts had been expecting starts to pick back up in July but at a slower 1.9 million unit clip.
Lower rates on home loans aided buyers last month. The average interest rate on a conventional 30-year mortgage dipped sharply to 6.06 percent in July from June's 6.29 percent.

Permits for future building activity were also up in July, increasing 5.7 percent to a 2.055 million annual rate -- well ahead of the 1.950 million pace expected on Wall Street.

"Building permits are a leading indicator of housing, suggesting that not only was housing strong in July but it's likely to remain strong in the foreseeable future," said Hugh Johnson, chief investment officer at First Albany Corp.

OIL WILD CARD

The biggest cloud on the inflation horizon has been oil prices and while U.S. consumers felt some energy price relief in July, this could be short lived.

U.S. crude prices closed at a record high $46.58 on Friday, although they have eased this week. Benchmark light crude was trading around $45.73 a barrel early on Tuesday.

Last week, when Fed officials raised interest rates a quarter-percentage point to 1.5 percent, they said the run-up in energy prices was likely a big factor behind the slower pace of U.S. economic growth in recent months.

Still, they said the expansion appeared poised to gain steam and offered no sign of willingness to abandon a "measured" campaign of rate rises.

Indeed, officials could embark on more aggressive rate rises if oil price gains fuel workers' wage demands or if businesses try to jack up prices to cover their fuel bills. But the report on consumer prices suggested that is not an immediate concern.

Easing inflation in July had the effect of pushing up inflation-adjusted earnings. Real average weekly earnings, which posted a big 0.8 percent drop in June, rose 0.7 percent last month, according to a separate Labor Department report. Still, over the last 12 months, they are down 0.7 percent.

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