Inflation slows to half-century low in 2008

By Lucia Mutikani

WASHINGTON (Reuters) - Inflation slowed to a half-century low last year and industrial output fell for the first time since 2002, data showed on Friday, as the recession deepened toward year-end, raising the specter of deflation.

With consumer confidence remaining at depressed levels, the reports suggested the economy could take longer to pull out of a downturn that is on track to be the longest and possibly deepest since World War Two.

"We seem to be digging an economic hole of major proportion which will only add time to the turnaround," said Kevin Giddis, head of fixed-income sales, trading and research at Morgan Keegan in Memphis, Tennessee.

The Consumer Price Index dropped 0.7 percent in December, a third straight monthly decline, capping a year in which prices advanced only 0.1 percent -- the weakest 12-month reading since December 1954, the Labor Department said.

Weakening economic activity worldwide has depressed commodity prices, pulling headline inflation figures down sharply.

But core U.S. inflation, which strips out volatile food and energy costs, is also slowing, increasing the risk of deflation.

On Wall Street, markets were little moved by the data, which was overshadowed by an announcement overnight of more government aid to the Bank of America. The Dow Jones industrial average ended 0.84 percent higher at 8,281.22 points.

U.S. Treasury debt prices slid and the dollar fell broadly amid worries about a huge supply overhang from government measures to stabilize the banking system and economy.

Analysts said the inflation report, coming on the heels of data on Thursday that showed a fifth straight decline in U.S. producer prices in December, marked the shift toward technical deflation in the headline CPI number.

"It just confirms that there is no inflation. We have to worry about deflation," said Robert MacIntosh, chief economist, Eaton Vance Corp in Boston. "The economy is weak enough that you can actually have falling core CPI for a little bit."

Deflation, which is a sustained decline in price levels, is regarded as dangerous because it stifles economic growth.

Mounting job losses, falling household wealth and tight credit conditions have forced consumers to hold back on spending, limiting businesses' ability to raise prices and encouraging some to offer heavy discounts to lure customers.

INDUSTRIAL OUTPUT SHRINKS

With U.S. consumers retrenching, industry is cutting back sharply. The Federal Reserve said on Friday that U.S. industrial production dropped 2 percent last month, capping a dismal year for manufacturing as the recession took hold.

For the fourth quarter, industrial output fell at an 11.5 percent annualized rate. Compared with December 2007, industrial production was down 7.8 percent, the biggest 12-month drop since September 1975.