There was modest good news on the inflation front in September as producer prices rose 0.4%, with the core rate rising 0.1% -- two readings that suggest the nation is avoiding deflation, a period of sustained price declines that could push the nation back into recession.

The Federal Reserve actually wants the economy to exhibit some inflation, as long as it remains low, and last month the Fed got precisely that. September's top-line 0.4% increase was concentrated in food and energy price rises at the wholesale level. Beef prices surged 7.6% and liquefied petroleum gas jumped 6.1%.

Economists surveyed by Bloomberg had predicted producer prices overall and the core rate would increase by 0.1% in September, after an 0.4% overall rise in August with a core rate increase of 0.1%.

Year-Over-Year Wholesale Inflation Rises

Although the economy is showing signs of inflation acceleration at the producer level, much of the growth is concentrated in the food and energy sectors. During the past 12 months, inflation at the wholesale level has increased 4%. That's higher than the 3.1% year-over-year rate recorded in August. Wholesale prices rose 4.4% in 2009 and 0.9% in 2008.

However, take away the often-volatile energy and food component, and the inflation rate for the past year becomes much smaller, although the annual core rate did rise in September. Core producer prices are up 1.6% over the past year. That's higher than the 1.3% year-over-year core rate recorded in August, but still within the Fed's "comfort zone" for inflation.

When it reacts to these numbers, the Fed concentrates on the core PPI, essentially asking: "What's happening to the cost of goods and services, excluding factors that businesses can't possibly control?" While the link between producer prices and consumer prices is imperfect, investors should be aware that the Fed is trying gauge enduring demand, and its impact on prices, and exclude demand that may disappear in a month or a season.

Fed's Goal: A Little Inflation

In September, prices for finished goods rose 0.4%, intermediate materials and supplies increased 0.5%, capital equipment rose 0.1%, and crude materials for processing fell 0.5%. It was the fourth rise in producer prices since March, and it may be just what the Federal Reserve needs.

A little inflation at the wholesale level is beneficial because it shows that deflation hasn't taken hold in the U.S. economy, despite the nation's now substantially smaller workforce and globalization's cost-cutting impact. Deflation robs companies of revenue, and can lead to a recession, or even worse economic conditions -- and it's a price scenario that the Fed would go to considerable efforts to quash should it threaten to surface.

September's producer price report indicates a U.S. economy that continues to exhibit a mix of industries with pricing power (those that are raising prices) and sectors under pricing pressure (those that are cutting them) at the wholesale level. But, so far, the nation has avoided lapsing into deflation. The current situation is best described as one of disinflation and low inflation, conditions that, at a minimum, should enable the Fed to keep stimulating the economy by maintaining its "extended period" of loose, low-interest rate monetary policy though the winter.

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