US consumer prices drop, complicating Fed rate hike decision

A tame inflation complicates the Federal Reserve's decision whether to raise interest rates this week. Data show that despite many signs of economic improvement, the pace of growth of US consumer prices last month was well below the central bank's target. 

Prices of US consumer goods in August fell for the first time in seven months, complicating the Federal Reserve's decision whether to raise interest rates.

The Consumer Price Index, which measures inflation or what people pay for goods, edged down 0.1% last month, according to the Labor Department.

The drop reflects the impact of cheap gas as well as a strong dollar on the cost of goods. Gas prices, which have resumed their decline after rising for a few months, are now about 35% below their level a year ago. The decline came as a result of a glut in supply and weak demand.

The tame inflation puts Fed officials in a bind as they start a two-day meeting Wednesday to determine whether to raise interest rates, which have been near zero since the 2008 financial crisis.

"Despite many signs of stronger growth - jobs, retail sales, auto sales, home sales - there is very mild inflation pressure," economist Jennifer Lee told the Associated Press. "This is a tough call for the Fed."

Apart from consumer spending, housing, and employment, the central bank is closely watching inflation, which has been weak since the US came out of a recession more than six years ago. It wants to see inflation heading towards 2% before raising rates to prevent the economy from overheating.

The key index that the Fed prefers to use to monitor inflation is the Commerce Department's core CPI, which excludes volatile energy and food prices. That gauge rose just 1.2% in the year through July, well below the Fed's target.

The International Monetary Fund has warned against hiking rates, saying doing so at this time, when financial markets are volatile, puts the global economy's expansion at risk. Higher rates could lead to a stronger dollar as well as capital flight from emerging markets into the US. 

"The prudent risk management approach would argue for them to hold off, but if the Fed was really data dependent there is a very a strong case to raise rates on Thursday," economist Ryan Sweet told Reuters.

The Fed might also have to wait and see how the slowdown in China would affect the US economy.