By Nell Henderson
Washington Post Staff Writer
Tuesday, August 16, 2005; 3:18 PM

Consumer prices rose faster than most workers' wages last month as energy costs surged again, the Labor Department reported today.

The department's consumer price index, a widely followed inflation gauge, rose 0.5 percent in July, the biggest increase since April.

The CPI's rise primarily reflected the 3.8 percent increase in energy prices, including a 6.1 percent jump in gasoline prices.

That left consumer prices 3.2 percent higher last month than they were a year before, the report showed.

Wages have lagged, by comparison, the department said in a separate report. After adjusting for inflation, average weekly earnings for private production and non-managerial employees fell last month by 0.2 percent. Those wages bought 0.5 percent less last month than they did in July of last year, after adjusting for price increases. These workers account for 80 percent of the labor force.

The U.S. economy has grown at a healthy pace this year, and even showed signs of gaining momentum in recent weeks, despite a 14.2 percent rise in energy prices over the 12 months that ended in July. Consumers have been snapping up autos and bidding up home prices with gusto, while businesses have boosted their spending on equipment and software.

But many analysts remain concerned that the expansion may slow sharply if rising energy prices force consumers to cut their spending on other items and cause businesses to pull back on new investments.

The CPI rose 3.2 percent in the 12 months that ended in July, representing "a significant dent in real disposable incomes and a threat to consumer spending," said Julian Jessop, an economist with Capital Economics Ltd.

But shoppers found lots of bargains on other items last month, the CPI report showed. Auto dealers heavily discounted new vehicles while retailers slashed prices on clothing. Prices dropped for televisions and audio equipment, personal computers and telephone services.

Those declines nearly offset price increases for many other items, including air fares, medical care, housing and education. Food costs rose a modest 0.2 percent last month.

As a result, inflation remained subdued in July outside of energy, the CPI report showed. The so-called core-CPI, which excludes food and energy prices, edged up just 0.1 percent in July, the same pace as the previous two months, and is up just 2.1 percent from July of last year.

Global and domestic competition has made it very difficult for businesses to pass on their energy costs by raising prices on many products. Higher gasoline prices, by cutting into consumer spending power, also may be forcing some businesses to lower prices, said Mark Vitner, senior economist with Wachovia Economics Group.

"While it seems counterintuitive, higher gasoline prices are actually helping restrain core inflation," Vitner wrote in an analysis. "With more money being spent for gasoline, consumers have fewer dollars left for discretionary purchases. The net result is that firms are slashing prices on everything from cars to beer in order to move product."

Federal Reserve officials agree that energy costs are the primary source of inflation now. But they also see potential seeds of future inflation in the economy's brisk rate of growth and the steady improvement of the labor market.

The Fed has been raising its benchmark short-term interest rate steadily for more than a year to keep the lid on inflation. Fed officials moved the federal funds rate up to 3.5 percent last week and indicated it is likely to keep lifting it gradually higher in the months to come.

Analysts are predicting the Fed will stop at somewhere between 4 and 5 percent, depending on how inflation behaves.

One factor that may influence the Fed's actions will be energy prices. If they stabilize, that would make it easier for the Fed to stick to a gradual, or "measured," pace of rate increases. But if oil prices continue shooting up, they could cause growth to slow sharply while pushing core inflation higher. A serious slow-down might cause the Fed to pause and leave interest rates unchanged for a while, but not if core inflation appeared headed upward in a lasting way.

"If there are signs in coming months that higher energy prices are raising the core inflation rate, then the Fed will have to keep tightening even if growth slows," said Nigel Gault, U.S. economist for Global Insight, Inc. "But if rising gasoline prices squeeze consumer spending and slow the economy while core inflation remains steady, the Fed might be able to pause before it reaches our [predicted] target rate of 4.5 percent in February."

The CPI report is "consistent with the view that growth is still fairly solid and core inflation is still relatively tame," said Kevin Cummins, an economist at UBS Securities, LLC. "Still, a key issue now will be whether the latest spike in gasoline prices leads to another "soft spot" in consumer spending."