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By Tim Ahmann
WASHINGTON, Aug 16 (Reuters) - U.S. consumer prices barely edged higher in July as a sharp drop in clothing prices helped temper rising food, energy and medical care costs, the government said on Friday.
The consumer price index, the main U.S. inflation gauge, rose just 0.1 percent last month after an identical advance in June, the Labor Department said.
Excluding food and energy prices, which can vary widely from month to month, the so-called core CPI was up 0.2 percent in July, after a 0.1 percent climb in June. Part of the July rise could be pinned on a turnaround in communication costs, which rose 0.9 percent after falling 0.1 percent in June.
With inflation under wraps, economists say the Federal Reserve has room to hold the benchmark federal funds rate at a four-decade low of 1.75 percent for a prolonged period, or even reduce it further if needed to prod the economy forward.
"It's clearly suggesting that inflation is not a concern on the Fed's radar screen right now," said Richard Yamarone, senior economist at Argus Research.
The report came in close to Wall Street's expectations. Economists polled by Reuters had forecast both the overall and core indices would show increases of 0.2 percent for July.
FOOD RISES
The department said food prices, which were flat in June, increased 0.2 percent in July.
In addition, energy prices moved up 0.4 percent with the price of gasoline climbing a sharp 1.5 percent and fuel oil costs up 0.9 percent.
Those gains more than offset drops of 0.5 percent for electricity prices and 0.1 percent for natural gas.
Clothing prices fell sharply for the fourth straight month in July, dropping a hefty 1.0 percent, while tobacco prices were unchanged, but medical care costs resumed their quick ascent, posting a 0.7 percent rise.
Overall the report painted a picture of tame inflation, with the CPI up just 1.5 percent for the 12 months ending in July and only 2.2 percent taking out food and energy costs.
"I think the fact that inflation is so tame certainly gives the Fed leeway to ease if necessary." said Jim O'Sullivan, senior economist at UBS Warburg.
Recent signs suggesting a loss of economic momentum have some investors betting rates will fall, although many economists think the recovery will exhibit enough strength for the Fed to refrain from adding to last year's 11 rate cuts.
After meeting on Tuesday, Fed policymakers said weakness was now the greatest threat facing the economy, a shift in the view they had laid out since March that risks were balanced between inflation and the possibility of waning growth.
However, they also said the current federal funds rate, which they've held in place since December, should prove low enough to ensure the recovery doesn't fall off the rails.
NEW GAUGE
In addition to the regular CPI, the department released a new inflation index designed to better reflect changes in the cost of living.
This so-called chained CPI was unchanged in July and up only 1.1 percent over the past 12 months. Unlike the main CPI, the new index is not adjusted for seasonal fluctuations and, as such, the monthly figures from the two series are not necessarily comparable.
In addition, the chained measure will be revised twice in the future, while the main CPI will not.
The new index is designed to capture the tendency of consumers to buy a lower-cost item when another item's price rises. In contrast, the old index tracks prices in a fixed market basket, failing to reflect this substitution effect.
Labor has estimated the new chained CPI will advance 0.1 percentage point to 0.2 percentage point less each year than the main index.
In a separate report, the department said average weekly earnings fell 0.8 percent in July when adjusted to take into account rising consumer prices -- bad news for consumers who have already seen their equity wealth take a plunge. The drop reflected a sharp decline in average weekly hours.