Nov. 18 (Bloomberg) -- Prices paid to U.S. producers plunged in October by the most on record as the faltering global economy caused demand for commodities to dry up.

The 2.8 percent drop was larger than forecast and followed a 0.4 percent decline in September. The figures from the Labor Department came after the U.K. reported the biggest decrease in its inflation rate in at least 11 years, signs that deflation may be added to the list of economic challenges facing President-elect Barack Obama in January.

A collapse in demand is forcing companies including Dow Chemical Co., the largest U.S. chemical maker, to charge lower prices and has brought automaker General Motors Corp. to the brink of bankruptcy. Central banks are likely to keep cutting interest rates, with some benchmarks approaching zero percent, as a global recession increases the threat of deflation.

“Fuel prices are falling like a stone and will continue to drop,” said Michael Gregory, a senior economist at BMO Capital Markets in Toronto, who had forecast a 2.5 percent decline in the PPI. “The drop in consumer spending is going to cause a ripple effect all along the supply chain in disinflationary pressures, if not deflationary pressures.”

Private reports today showed more deterioration in the U.S. housing market, where the financial crisis and the economic slump began. Home prices fell in 80 percent of U.S. cities in the third quarter, according to figures from the Chicago-based National Association of Realtors.

No Confidence

Confidence among U.S. homebuilders in November dropped to the lowest level since record-keeping began in 1985, according to the National Association of Home Builders/Wells Fargo. The index of builder confidence decreased to 9, lower than forecast, from 14 in October. A reading less than 50 means most respondents view conditions as poor.

Congressional Democratic leaders are pressing the Bush administration to use funds from the government’s financial- rescue program to help automakers and homeowners. Treasury Secretary Henry Paulson rejected that idea, telling a House committee the $700 billion Troubled Asset Relief Program “is not a panacea for all our economic difficulties.”

Stocks rose and Treasuries fell. The Standard & Poor’s 500 Stock Index climbed 1 percent to close at 859.12. Yields on benchmark 10-year Treasury notes were at 3.53 at 4:16 p.m. in New York, down from 3.65 late yesterday.

More Than Anticipated

Wholesale prices were projected to decline 1.9 percent, according to the median of 76 forecasts in a Bloomberg News survey. Estimates ranged from declines of 0.3 percent to 2.8 percent. The Labor Department’s producer-price index figures date to 1947.

So-called core producer prices that exclude fuel and food rose 0.4 percent, indicating that the declines in raw-material costs have yet to feed through to other products. Core prices were projected to rise 0.1 percent, according to the survey median.

This month’s increase in the core rate “will reflect the high-water mark because companies are just not going to keep raising prices with spending falling,” Gregory said. “The wholesale picture is going to look very much like disinflation as time goes by.”

The U.K. inflation rate fell more than economists forecast in October, recording the steepest drop in at least 11 years, the Office for National Statistics said today in London. Consumer prices rose 4.5 percent from a year earlier, compared with 5.2 percent the previous month.

Smaller Gain

Prices paid to U.S. producers rose 5.2 percent from October 2007, after an 8.7 percent gain in the 12 months ended in September.

Excluding food and energy, the increase was 4.4 percent from a year earlier, the most since 1989.

The drop in wholesale prices was led by a 13 percent decline in fuel costs, the biggest since 1986, and a 0.2 decrease in the cost of food.

Producer prices are one of three monthly inflation gauges reported by Labor. Prices of goods imported into the U.S. fell last month by the most on record, a report last week showed.

A report tomorrow may show consumer prices dropped 0.8 percent in October, the most since 1949, according to the Bloomberg survey.

Figures this month indicate prices will keep dropping. The government asks producer-price survey participants to report costs for the Tuesday of the week that includes the 13th. On that basis, crude oil fell 24 percent in October from the prior month on the New York Mercantile Exchange. Oil slid another 25 percent a barrel this month.

Record Declines

The costs of intermediate and crude goods, used in the earlier stages of production, also dropped by records, indicating price pressure may keep subsiding.

After contracting at a 0.3 percent annual pace in the third quarter, the U.S. economy may shrink again this quarter and the first three months of 2009, according to a Bloomberg survey conducted from Nov. 3 to Nov. 11. The slump would be the longest since 1974-75.

Europe and Japan slipped into a recession last quarter, and China’s economy, the biggest contributor to global growth in 2007, is slowing.

The prices Dow charges for two of the most-used plastics, polyethylene and polypropylene, fell as much as 40 percent since September, giving up gains achieved since June, the company said. Midland, Michigan-based Dow is closing more factories as sales decline.

“This is as bad as we have ever seen it in our lifetimes,” Chief Executive Officer Andrew Liveris said in a Nov. 13 interview. An increase in prices “is probably going to be near impossible in the next three to six months.”

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

Last Updated: November 18, 2008 16:24 EST