WASHINGTON (Reuters) - U.S. producer prices unexpectedly fell in August, recording their first drop in 1-1/2 years, as declines in the prices of food and a range of trade services offset an increase in the cost of energy products.

A farmer harvests his field at his farm in Pecatonica, Illinois, U.S., July 25, 2018. REUTERS/Joshua Lott

Despite the surprise weakness in producer prices reported by the Labor Department on Wednesday, overall inflation is steadily rising, driven by a tightening labor market and robust economy.

The Federal Reserve is expected to raise interest rates later this month for the third time this year.

“Inflation pressures should intensify in coming quarters,” said Ryan Sweet, a senior economist at Moody’s Analytics in West Chester, Pennsylvania. “The unemployment rate is low, GDP growth is above trend, wage growth is accelerating ... and fiscal policy is supportive for the economy.”

The producer price index for final demand slipped 0.1 percent last month after being unchanged in July. August’s fall in the PPI was the first since February 2017. That further lowered the annual increase in the PPI to 2.8 percent from 3.3 percent in July.

Economists polled by Reuters had forecast the PPI increasing 0.2 percent in August and advancing 3.2 percent year-on-year.

A key gauge of underlying producer price pressures that excludes food, energy and trade services edged up 0.1 percent last month. The so-called core PPI gained 0.3 percent in July.

In the 12 months through August, the core PPI increased 2.9 percent after rising 2.8 percent in July.

The dollar was trading lower against a basket of currencies, while U.S. Treasury prices rose. Stocks on Wall Street were mixed.

DECLINING MARGINS

The correlation between producer and consumer prices has weakened after the government revamped the PPI basket and changed the methodology several years ago.

The Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index excluding food and energy, increased 2.0 percent in July, hitting the U.S. central bank’s 2 percent target for the third time this year.

Government data on Thursday is expected to show consumer prices rising 0.3 percent in August after gaining 0.2 percent in July, according to a Reuters survey of economists.

There has so far been no widespread price increases from the Trump administration’s import tariffs on lumber, washing machines, solar panels, steel and aluminum, as well as a range of Chinese goods.

But with the trade war between the United States and China escalating, economists believe this will change and expect the import duties to boost inflation in the coming months. Recent manufacturing surveys continue to show increases in raw material prices amid growing strains on the supply chain.

Wholesale food prices fell 0.6 percent in August, pulled down by sharp declines in the costs of eggs and fresh fruits and melons. Food prices, which dipped 0.1 percent in July, have now decreased for three straight months.

Wholesale energy prices rose 0.4 percent in August, with gasoline prices surging 0.6 percent after slipping 0.1 percent in the prior month. Energy prices fell 0.5 percent in July.

Overall, the cost of wholesale goods was unchanged in August after edging up 0.1 percent in July. Prices for iron and steel scrap fell 5.6 percent last month, the biggest drop since October 2017. Nonferrous scrap prices decreased 8.7 percent, the largest decline since January 2009.

The cost of services slipped 0.1 percent last month, led by a 0.9 percent decline in the index for trade services, which measures changes in margins received by wholesalers and retailers. Services dipped 0.1 percent in July.

Over 80 percent of the drop in the cost of services last month was attributed to margins for machines and equipment wholesaling, which fell 1.7 percent.

“Declining margins at machinery and equipment firms suggest producers may be struggling to pass on rising input costs related to recent tariffs,” said Sarah House, a senior economist at Wells Fargo Securities in Charlotte, North Carolina.

The cost of healthcare services rose 0.3 percent as a 0.5 percent drop in prices for hospital outpatient care was offset by a 0.6 percent jump in the cost of doctor visits, which was the largest gain since June 2010. There were also increases in prices of hospital inpatient and dental care.

Healthcare prices ticked up 0.1 percent in July. Those healthcare costs feed into the core PCE price index.