updated 9/12/2008 8:49:39 AM ET 2008-09-12T12:49:39

Wholesale inflation plunged in August by the largest amount in nearly two years, reflecting a steep drop in gasoline and other energy products.

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The Labor Department reported Friday that wholesale prices fell 0.9 percent last month, nearly double the 0.5 percent decline that economists had been expecting. The price moderation followed three months in which wholesale costs had shot up at levels exceeding 1 percent a month as energy costs had surged.

Core inflation, which excludes energy and food, was also well-behaved, edging up just 0.2 percent in August, right in line with expectations, and well below the 0.7 percent spike of the previous month.

In other economic news, the Commerce Department reported that retail sales unexpectedly fell by 0.3 percent in August following 0.5 percent decline in July. July's data was revised to a weaker performance than first reported.

The sharp retreat in wholesale prices will be welcome news at the Federal Reserve, which had been worried that it might have to start raising interest rates if inflation pressures did not start to moderate.

Fed officials are expected to keep rates unchanged when they meet next Tuesday and with inflation retreating, they will likely hold rates steady for the rest of this year.

If the Fed had been forced to start raising interest rates it would have presented another problem for an economy facing a host of headwinds from rising unemployment, a prolonged housing recession, a severe credit crunch and a troubled financial system.

The 0.9 percent drop in wholesale prices, the largest one-month decline since October 2006, could show up in lower prices for shoppers eventually. The August report on consumer prices will be released next Tuesday.

Even with the August decline, wholesale prices over the past 12 months are up by 9.6 percent, the second biggest 12-month price change in the past 27 years, exceeded only by a 9.8 percent jump for the 12 months ending in July.

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