Producer prices set record drop in October

WASHINGTON (Reuters) - Producer prices posted a record decline in October as weak economic growth sent energy prices tumbling and chain store sales slipped, data on Tuesday showed, while home prices fell sharply in the third quarter.

A global credit crunch has depressed prices for commodities like oil and alarmed central banks that a general deflation in prices could ensue as advanced economies tip into recession.

Federal Reserve Chairman Ben Bernanke told U.S. lawmakers that credit markets had steadied a bit after hefty interest rate cuts and massive injections of liquidity, but remained under considerable strain.

Longer-dated U.S. government debt prices rose as investors bet on lower inflation after the Labor Department said the producer price index fell by 2.8 percent last month.

Energy prices were off 12.8 percent, the largest drop since 1986, while gasoline prices shed a record 24.9 percent.

"The headline number coming much lower than expected really underscores the disinflationary numbers coming in here. The good news is that it really gives the Fed a lot of flexibility to manage rates lower," said Craig Peckham, an equity trading strategist, at Jefferies & Co in New York.

The U.S. central bank has slashed interest rates 4.25 percentage points since September 2007 to 1 percent and is expected to trim its target benchmark overnight rate again before the end of the year.

Analysts polled by Reuters had forecast a 1.8 percent decline in the overall producer price index last month.

This measure of prices paid at the farm and factory gate has increased 5.2 percent over the last year, a slowdown from the 8.7 percent annualized growth notched in September.

Core producer prices excluding food and energy costs rose by 0.4 percent in October, compared with expectations for a 0.1 percent increase, and were up 4.4 percent over the last 12 months -- the steepest increase since 1989.

Higher core producer prices potentially cloud the outlook for lower inflation but analysts were pretty confident that the gloomy economy would squeeze inflation hard.

"It should not be a surprise there's some pass-through from energy to the core, but that should fade. There should be increasing slack as the economy weakens," said James O'Sullivan an economist with UBS Securities LLC in Stamford, Connecticut.

The credit crisis has roiled international financial markets and panicked investors into massive purchases of dollar-denominated assets as a safe haven in troubled times.

The U.S. Treasury Department said that foreigners bought a net $143.4 billion in U.S. securities in September, the biggest capital inflow in nearly three years.

U.S. growth has slowed sharply since the collapse of the housing market last year and the National Association of Realtors separately said single family home prices fell 9.0 percent in the third quarter from the same period in 2007.

In addition, it said that 35-40 percent of all sales in the third quarter were distressed sales of homes that took place either through foreclosure or short-sales, which in housing means it sold for less than was owed the property.

Falling home prices has sapped spending as households feel less wealthy and take fright at mounting unemployment.

U.S. chain-store sales shrank 0.9 percent last week compared with the same period a year again, according to the Johnson Redbook Retail Sales Index. In November-to-date, sales were down 1.1 percent compared with the previous month.

(Additional reporting by Richard Leong, Deepa Seetharaman and John Parry in New York; David Lawder, Lucia Mutikani and Mark Felsenthal in Washington, Editing by Gary Crosse)