WASHINGTON (MarketWatch) - In another sign of the depth of the global economic slowdown, U.S. consumer prices increased just 0.1% in 2008, the smallest increase in 54 years, the Labor Department reported Friday.

The consumer price index fell 0.7% in December, the third decline in a row, led by an 8.3% drop in energy prices and a 0.1% drop in food prices. Economists surveyed by MarketWatch had given an average expectation for a 0.8% decline. See Economic Calendar.

The CPI hasn't risen since its 0.8% gain in July, after which energy and commodity prices plunged. Read the full government report.

Core prices -- which exclude food and energy prices -- were flat in December for the second straight month, as expected. The core CPI hasn't risen since September.

Consumer prices were up 0.1% in 2008, the slowest annual inflation since prices fell 0.7% in 1954. The core CPI was up 1.8% in 2008, the smallest increase since 2003.

If the CPI had fallen 0.8% in December as expected, prices would have been down for the year as a whole.

A separate CPI for urban workers showed prices fell 0.5% in 2008, the biggest decline since 1949. The CPI-W is used for many cost-of-living adjustments.

With prices for urban workers down 0.9% in December and average weekly earnings down 0.3%, real weekly earnings -- those adjusted for inflation -- rose 0.6%. For all of 2008, real earnings were up 2.9%.

Falling prices have been a boon for consumers, but have devastated corporate profit margins, leading to even more layoffs and production cutbacks.

Most economists expect inflation to ease for much of this year as global demand weakens. Federal Reserve officials say they aren't especially concerned about deflation taking hold, and insist that they are ready to shrink the money supply once the economy begins to recover in order to prevent a bout of inflation next year.

"Our latest forecast shows the core slipping to 1% by the end of 2009, consistent with a growing output gap that is expected to reach 6%," wrote David Greenlaw and Ted Wieseman, economists for Morgan Stanley. "Even with energy prices having flattened out of late, the deflation risk confronting the U.S. economy is real."

In a separate report released Friday, the Federal Reserve said industrial output plunged 2% in December, much more than expected. See full story on industrial output.

In a separate report, the consumer sentiment index rose to 61.9 in January from 60.1 in December. See full story.

Details of CPI

In December, prices were flat or falling in most major consumer categories, with health and education serving as the exceptions.

Energy prices fell 8.3%, including a 17% drop in gasoline prices and a 13% drop in fuel oil prices. Excluding energy, the CPI was flat.

Food prices fell 0.1%, led by declining prices for fruits, vegetables, dairy and meat.

Shelter prices -- which represent about a third of the CPI -- were flat in December. Hotel rates fell 0.7%, rents rose 0.2%, and homeownership equivalent rent rose 0.1%.

Apparel prices fell 0.9%.

Transportation prices fell 4.4% on lower fuel bills. Airfares fell 1.2%. New vehicle prices fell 0.4%.

Medical care prices increased 0.3%.

Education and communication prices rose 0.3%, led by a 0.6% rise in tuition.