Consumer prices drop by most in 3 years

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By msnbc.com staff and news wires
U.S. consumer prices fell in May by the most in over three years as households paid less for gasoline, possibly giving the U.S. Federal Reserve more room to help an economy that is showing signs of weakening.

The Labor Department said on Thursday its Consumer Price Index dropped 0.3 percent last month after being flat in April. May's decline was the sharpest since December 2008 although analysts polled by Reuters expected a bigger decline.

Outside the volatile food and energy category, inflation pressure appeared to be modest. Core CPI climbed 0.2 percent higher as expected, matching the increase posted in April.

Mild price increases leave consumers with more money to spend, which boosts economic growth. Lower inflation also gives the Fed more leeway to keep interest rates low.

Steady increases in rents for homes and apartments are pushing up core prices, though at a modest pace. Rents are increasing as more people forgo homeownership and rent instead.

Gas prices have tumbled 40 cents after peaking April 6. Prices at the pump averaged $3.54 on Wednesday, according to AAA. That's down 19 cents from a month earlier.

Still, American workers are seeing little growth in pay. Workers' average hourly earnings have risen just 1.7 percent in the past 12 months, less than the pace of inflation over that same period.

Without more jobs or higher pay, consumers could be forced to cut back on spending later this year. Consumer spending is critical because it accounts for 70 percent of economic activity

A small amount of inflation can be good for the economy. It encourages businesses and consumers to spend and invest money sooner rather than later, before inflation erodes its value.

The economy is growing but at a sluggish pace. That is keeping a lid on price increases. Slow growth makes it harder for consumers and businesses to pay higher costs. The economy expanded at just a 1.9 percent annual rate in the January-March quarter.

Lower prices also could make Fed Chairman Ben Bernanke more willing to take action to boost growth. If inflation was threatening to accelerate, Fed policymakers could feel compelled to raise interest rates or take other steps to fight rising prices. But with inflation tame, the Fed can focus on stimulating growth.

Reuters and The Associated Press contributed to this report.