U.S. Economy: Consumer Prices Fall as Deflation Looms

By Bob Willis and Timothy R. Homan

Nov. 19 (Bloomberg) -- The cost of living in the U.S. fell by the most on record and construction began on the fewest homes ever last month, evidence the economy is in the worst recession in at least a quarter century.

The consumer price index plunged 1 percent last month, the most since records began in 1947, the Labor Department said in Washington. Commerce Department figures showed housing starts tumbled to an annual rate of 791,000, indicating the industry's contraction may extend into a fourth year.

Today's CPI report signals deflation, or a prolonged price slide, may become another hazard facing Federal Reserve Chairman Ben S. Bernanke and President-elect Barack Obama. Deflation could worsen the economic downturn by making debts harder to pay off and countering the impact of Fed interest-rate cuts.

``The economy's really just in horrific shape,'' said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York. Fed officials will ``take rates as low as they have to'' to avoid ``a deflation-type scenario, which now all of a sudden is very possible.''

LaVorgna predicts the Fed will cut its main rate to 0.5 percent from its current 1 percent when it meets on Dec. 16.

Deflation Risk

Fed Vice Chairman Donald Kohn said today that while the risk of deflation is ``still small,'' policy makers must be ``aggressive'' in fighting the danger. The economy ``is declining right now'' and will record a couple of quarters of contraction, he said in answering questions after a speech in Washington.

Fed policy makers last month forecast the U.S. economy will contract through the middle of 2009, with some officials prepared to cut interest rates further in response, according to a record of the group's meeting.

``Some suggested that additional policy easing could well be appropriate at future meetings,'' the Fed said in minutes of the Oct. 28-29 Federal Open Market Committee meeting released today. ``In any event, the Committee agreed to take whatever steps were necessary to support the recovery.''

Treasuries advanced, and stocks plunged. Yields on benchmark 10-year notes fell to 3.36 percent as of 4:24 p.m. in New York, from 3.52 percent late yesterday. The Standard & Poor's 500 Stock Index closed down 6.1 percent at 806.58, extending its 2008 retreat to 45 percent.

Prices dropped last month as fuel costs plummeted and retailers used discounts for cars and clothing to entice consumers hobbled by job losses and sinking home values.

Cutting Prices

Target Corp. is among retailers cutting prices in an effort to lure cash-strapped holiday shoppers away from Wal-Mart Stores Inc., the discount retailer that last week reported a gain in third-quarter profit.

Excluding food and energy, so-called core prices unexpectedly fell 0.1 percent for the first decline since 1982.

``We are moving into an environment where prices are falling across the board,'' David Resler, chief economist at Nomura Securities International Inc. in New York, said in an interview with Bloomberg Television. ``That is going to continue. Deflation is spreading across the economy.''

Consumer prices were projected to fall 0.8 percent, according to the median forecast of 77 economists in a Bloomberg News survey. Estimates ranged from a decline of 1.2 percent to a gain of 0.4 percent. Costs excluding food and energy were forecast to rise 0.1 percent, the survey showed.

Annual Gain

Prices increased 3.7 percent in the 12 months to October, the smallest year-over-year gain since October 2007. They were forecast to climb 4 percent from a year earlier, according to the survey median.

The core rate increased 2.2 percent from October 2007, after a 2.5 percent year-over-year increase the prior month.

A slump in building permits signaled residential construction is likely to keep falling in the next couple of months. Permits dropped 12 percent to a 708,000 pace, the lowest since at least 1960, the report from Commerce showed.

Builders, already mired in a three-year housing slump, are finding it hard to attract buyers as property values drop and banks tighten lending standards.

Housing starts were projected to fall to a 780,000 annual pace from a previously estimated 817,000 in September, according to the median forecast of 75 economists polled by Bloomberg News. Estimates ranged from 700,000 to 870,000.

Compared with October 2007, work began on 38 percent fewer homes.

Core-Price Declines

The drop in core consumer prices reflected declines in the cost of clothing, automobiles, air fares and hotel rates. New- vehicle prices fell 0.5 percent and clothing costs dropped 1 percent. The price of airfares plunged 4.8 percent, the most since June 1999.

One benefit of falling prices can be seen in its effect on incomes. Today's figures also showed wages increased 1.4 percent after adjusting for inflation, following no change in September. They were still down 0.9 percent over the last 12 months. The decline in purchasing power is contributing to the slowdown in consumer spending.

Retail sales fell 2.8 percent last month, the most on record, Commerce Department figures showed last week. Mounting job losses and record foreclosures are causing American consumers, who account for more than two-thirds of the economy, to retrench.

Wal-Mart Discounts

Wal-Mart, the world's largest retailer, said yesterday it planned to reduce U.S. prices on Thanksgiving food and Christmas merchandise to lure customers during the holidays.

Target, the second-largest U.S. discounter, said this week it plans to add grocery items and offer ``sharper'' discounts to draw shoppers who are shunning jewelry, clothing and home goods, which account for more than 40 percent of its revenue.

``Right now, the consumer is very hesitant,'' Chief Executive Officer Gregg Steinhafel said during the company's Nov. 17 earnings call. ``They're very stressed.''

Obama and House Democrats are planning to spend as much as half a trillion dollars to stimulate the world's biggest economy and U.K. Prime Minister Gordon Brown pressed other leaders of the Group of 20 nations to follow that effort last weekend.

To contact the report responsible for this story: Bob Willis in Washington at bwillis@bloomberg.net; Timothy R. Homan in Washington at thoman1@bloomberg.net