Consumer Prices in Record Decline in October

NEW YORK (CNNMoney.com) -- Consumer prices fell by a record amount in October, in another worrisome sign about the contracting economy, the government reported Wednesday.

The Consumer Price Index, a key inflation reading, fell 1% last month, according to the Labor Department. That was much weaker than September's flat reading and exceeded the 0.8% decline a consensus of economists surveyed by Briefing.com had forecast.

Prices fell by the greatest amount since the Department of Labor began publishing seasonally adjusted changes in February 1947.

The issue of consumer prices has changed dramatically in recent months. For most of the year, inflation, driven by high energy prices has caused consumer prices to soar, reaching a 17-year high in July.

Now, economists are worried about deflation - the opposite of inflation. Falling prices may be a welcome sign for consumers in grocery store aisles and filling up at the pump, but deflation is generally a bad sign for the economy.

If prices fall below the cost it takes to produce products, businesses will likely have to cut production and slash payrolls. Rising unemployment would cut demand even further, sending the economy into a vicious circle.

But deflation is not yet here, and despite predictions of a long and deep recession, deflation may never rear its ugly head in this business cycle. The 1% fall in October left overall prices 3.7% above where they were 12 months earlier. That's down from the 4.9% rise on that basis in September, and it is the lowest level since October 2007.

Demand for consumer products took a sharp turn downwards in recent months as the credit crisis took hold. Consumer confidence fell to an all-time low in October, according to a recent Conference Board study. Consumers would rather save money than spend it, and for those who want to make big purchases, loans have been expensive and hard to come by.

As a result, the government has launched massive, multi-trillion dollar financial rescue effort aimed at stimulating lending and boosting the economy. But the global economic climate has taken a sharp turn for the worse since September. The stock markets have fallen drastically, and many experts believe the United States is in a recession.

As a result, the government now needs to worry about monetary policy that both stimulates the economy and boosts lending in order to get consumers interested in buying products again.

Core inflation: The closely watched core CPI, which strips out volatile food and energy prices, fell 0.1%. Economists had expected a 0.1% rise after a 0.1% jump in September. Core CPI posted a 12-month change of 2.2%, down from a 2.5% rise on that basis from the month before.

Food prices actually continued to rise - up 0.3% in October, but energy prices fell by a staggering 8.6% in the month.

Core inflation is now at its lowest point since October 2007, but it is still a bit above the perceived comfort zone of central bankers. The Federal Reserve is generally believed to want to see the 12-month change in core inflation readings remain between 1% and 2%.

Economists say falling prices could give the Federal Reserve more wiggle room for lowering interest rates. The Fed cuts its key funds rate to an all-time low of 1% in response to deterioration in global financial system, but those cuts tend to be inflationary.

On Tuesday, a separate Labor Department report showed wholesale prices also fell by a record amount in October as energy costs continued to decline.