Nov. 16 (Bloomberg) -- Consumer prices in the U.S. fell more than forecast in October, which may reassure Federal Reserve policy makers who last month described inflation as a bigger worry than a slowing economy.

The consumer price index dropped 0.5 percent, matching September's retreat, the Labor Department said today in Washington. Excluding food and energy, prices rose 0.1 percent, the smallest increase in eight months. In a separate report, the Fed said industrial production rose 0.2 percent in October.

Traders and economists initially seized on today's figures as evidence the Fed won't need to raise interest rates and may even cut them. Less inflation gives Chairman Ben S. Bernanke and his team more room to stimulate the economy should the housing downturn threaten to end the five-year expansion.

``The upward momentum in inflation has been broken,'' said Mark Vitner, a senior economist at Wachovia Corp. in Charlotte, North Carolina. ``The Fed has done its job.''

Bonds rallied in the minutes after the report was released, before erasing their gains. Stocks advanced. A subsequent report from the Philadelphia Fed showed manufacturing expanded for the first time in three months, pushing bonds lower. Fed officials cautioned about reading too much into October's figures.

`Right Direction'

``One month doesn't make a trend,'' Chicago Fed President Michael Moskow told reporters in his home town today after the inflation report. ``It is moving in the right direction. The key is whether this can be sustained,'' he said, adding that inflation isn't defeated. St. Louis Fed President William Poole said the economy isn't yet ``out of the woods'' on inflation.

Economists expected the consumer price index to fall 0.3 percent, according to the median of 76 forecasts in a Bloomberg News survey. Industrial production had been projected to rise 0.3 percent after a 0.6 percent drop in the prior month.

``We're in a soft-landing scenario, inflation is easing, and the Fed can have a more relaxed attitude about monetary policy,'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts. ``The big question is when, and not if, the Fed will ease interest rates. That might be as early as March.''

Minutes of the Fed's October meeting released yesterday showed inflation as the biggest concern of officials. There was no discussion of a cut in borrowing costs, the records show, putting their stance at odds with some traders and economists who anticipate a reduction.

Lehman's New Call

Policy makers have kept their benchmark lending rate at 5.25 percent for the past three meetings, following a two-year stretch of increases. After today's data, Lehman Brothers Holdings Inc. -- who still expect the Fed's next move to be an increase -- pushed back its estimate of when the Fed will tighten to March from January.

The drop in prices is making American's paychecks stretch further. Average weekly wages adjusted for inflation rose 3.2 percent in the year to October, the biggest gain since February 1998, the Labor Department said today.

Inflation also eased in Europe as the first annual drop in energy prices since 2004 kept the rate below the European Central Bank's limit for a second month. Consumer prices rose 1.6 percent from a year earlier, the lowest since February 2004, the European Union reported today.

Excluding food and energy costs, the American index was forecast to rise 0.2 percent for a fourth straight month, according to the Bloomberg survey. Estimates of the increase ranged from 0.1 percent to 0.3 percent.

Energy Impact

On a year-over-year basis, consumer prices were up 1.3 percent, the smallest 12-month increase since June 2002, compared with 2.1 percent during the 12 months ended in September. The smaller increase reflects a decline in energy prices from a year earlier, when they soared after Hurricanes Katrina and Rita disrupted production on the U.S. Gulf Coast.

Energy prices fell 7.0 percent in October, after a 7.2 percent decline the month before. Gasoline prices fell 11.1 percent, following a 13.5 percent decrease for September. Fuel oil costs fell 6.1 percent. Natural gas prices dropped a record 7.7 percent.

``That improvement in energy resonated through overall transport, and softer prices are showing up in less energy- dependent sectors like apparel,'' said Gregory Miller, chief economist at SunTrust Banks Inc. in Atlanta.

Core consumer prices rose 2.7 percent during the 12 months ended in October, compared with a 2.9 percent gain for the period ended in September. That increase was the biggest 12- month jump since February 1996.

Jobless Claims

Initial jobless claims fell 2,000 to 308,000 last week, the Labor Department said in another report. Claims are holding below last year's average 331,560.

The consumer price index is the government's broadest gauge of costs for goods and services. Almost 60 percent of the CPI covers prices consumers pay for services, ranging from medical visits to airline fares and movie tickets.

The producer price index, reported on Nov. 14, fell 1.6 percent in October and the measure excluding food and energy costs fell 0.9 percent, the biggest decline since 1993. Import prices, released last week, fell 2 percent.

New vehicle prices fell 0.1 percent.

So far this year, consumer prices are rising at a 2.4 percent rate, compared with 5.0 percent for the first 10 months of 2005. Core prices are rising at a 2.8 percent rate, faster than the 2.1 percent pace for the same period last year.

Food, Housing

Food prices, which account for about a fifth of the CPI, rose 0.3 percent in October for the second consecutive month.

Housing costs, which include some energy costs and account for one-third of the total consumer price index, were unchanged after rising 0.3 percent in September. A category designed to track rental prices rose 0.4 percent, compared with a 0.3 percent gain the month before.

Rising rents, which make up almost 40 percent of the core CPI, have been contributing to inflation as less affordable home prices make renting more attractive.

Airfares fell 1.4 percent in October. AMR Corp.'s American Airlines, Delta Air Lines Inc. and Continental Airlines Inc., three of the largest U.S. carriers, said Nov. 3 they raised fares $5 each way on most domestic flights.

The cost of medical care rose 0.3 percent for a second consecutive month.

Fed officials remained guarded against an extended period of high inflation and turned more optimistic on the outlook for growth, according to records of their meeting on Oct. 24 and 25.

``Nearly all participants viewed the current rates of core inflation as uncomfortably high and stressed the importance of further moderation,'' according to minutes of the meeting, released yesterday. ``Participants were concerned that inflation expectations could begin to drift upwards if core inflation remained elevated for a protracted period.''

To contact the reporter on this story: Courtney Schlisserman in Washington cshlisserma@bloomberg.net

Last Updated: November 16, 2006 15:42 EST