Consumer prices drop 0.7 percent on cheaper gas costs

A plunge in gas prices last month lowered consumer prices by the most in six years. But excluding the volatile food and energy costs, prices rose.

The consumer price index fell 0.7 percent in January, the sharpest drop since December 2008, the Labor Department said Thursday. Tumbling prices at the pump drove nearly all of the decline. Core prices, which exclude food and energy, rose 0.2 percent.

Despite the sharp drop in the overall index, economists see signs that many prices are moving higher. The cost of services, such as hotels, restaurant food and rents, all rose last month, lifting core prices.

Prices for services are rising as the U.S. economy has picked up, and falling unemployment is starting to lift wages, if still only slightly. Higher prices domestically are offsetting cheaper oil and a strong dollar, which is lowering import prices.

Overall consumer prices have slipped 0.1 percent over the past 12 months. It is the first year-over-year drop in five years. And over the past year, core prices have risen just 1.6 percent, below the 2 percent level the Federal Reserve considers optimal for a healthy economy.

Excessively low inflation is complicating the Fed's decision on when to begin raising the short-term interest rate it controls. Most analysts think the Fed will start to raise rates from record lows in June or September. But persistently low prices could delay that decision.

Fed Chair Janet Yellen told Congress this week that she expects the effects of falling gas prices to fade in coming months, causing inflation to creep back toward the Fed's 2 percent target.

Most economists agree. Paul Ashworth, chief U.S. economist at Capital Economics, expects core inflation to rebound to 2 percent by early next year.

"There is little danger that this temporary bout of falling energy prices will develop into a more insidious ... deflation spiral," Ashworth said.

Deflation, which occurs when prices are broadly falling, can feel like a good thing to consumers but can be damaging for an economy. Declining prices can lead consumers to delay spending as they wait for better deals. That slows growth and forces companies to cut wages. Japan has struggled to escape a deflationary, slow-growth trap for more than two decades.

Yet Ethan Harris, global economist at Bank of America Merrill Lynch, says price declines driven by cheaper gas typically don't cause deflationary spirals. Instead, lower gas prices free up more cash for Americans to spend, which tends to strengthen economic growth.

In addition, there are already signs that oil and gas prices have leveled off after collapsing nearly 60 percent from July through January.