Falling services costs drove US wholesale inflation down in July, marking the first contraction in nearly a year, the Labor Department reported Thursday.
The dip in the Producer Price Index reversed the modest gain seen in June and could further weaken the case for continued interest rate tightening by the Federal Reserve.
PPI, which measures costs of wholesale goods and services, fell 0.1 percent in July, the first decline since August of last year, according to the report, confounding economists who expected a 0.2 percent increase. The decline was driven by a 0.2 percent drop in final demand services.
The PPI for the latest 12 months also shrank, falling a tenth of a point from June to 1.9 percent. The year-on-year measure has fallen six-tenths of a point in the last three months.
The central bank had been expected to raise the benchmark lending rate a third time this year, but some economists are now ruling that out due to persistently weak inflation.
Asked about the issue, New York Federal Reserve Bank President William Dudley said he still expects to see price pressures emerge, given tight labor markets that should eventually produce higher wages.
"I would expect the inflation data will show a little bit more upward pressure than what we have seen over the last four months or so," Dudley told reporters.
However, he said the 12-month inflation rates likely will remain below the Fed's two percent target for some time as the weak monthly numbers hold down the year-over-year calculation.
The Fed targets consumer price inflation as measured by the Personal Consumption Expenditures price index, but some of the factors are the same across all inflation measures.
In addition to the low unemployment rate, Dudley said the US dollar is weakening "so that should have some consequences for import prices," which in turn will push up depressed goods prices.
- 'Stunning array' of price declines -
Excluding the volatile food, fuel and trade categories, prices were flat for the month, compared to the expected 0.2 percent increase, while the 12-month measure dropped a tenth of a point to 1.9 percent, the third straight decline.
Much of the decrease in PPI last month was driven by services, including a record drop for services tied to chemicals and related products, which fell 5.8 percent, the largest drop in seven years.
Chris Low of FTN Financial said the report showed a "stunning array" of falling prices.
"Despite economists' conviction inflation is about to accelerate, prices are in retreat," he wrote in a research note. He said a weakening US dollar convinced some economists that inflation would finally kick in by July.
"Their conviction was undoubtedly struck a blow this morning as wholesale prices should be more sensitive to movement in the dollar than retail prices," Low said. 
"The drop in both headline and core PPI suggests companies are compressing margins, weak dollar or not."
Services showed signs of weakness in areas besides chemicals wholesaling, including airline passenger services which fell 2.7 percent, the largest decrease since March. 
Other declines were recorded in machinery and equipment, paper and plastics, auto parts, software publishing and portfolio management, among others.
Energy prices helped weigh down the index, with natural gas falling 2.7 percent and gasoline declining by 1.4 percent. And wholesale costs for beef and veal fell 12 percent, the largest decrease since October 1973.
There were gains in some categories, with hospital outpatient care rising 0.6 percent, diesel fuel gaining 9.8 percent, hotel accommodation adding 2.2 percent and prices for grains increasing by a sharp 17.1 percent.