U.S. inflation rises, trade gap shrinks sharply

WASHINGTON Wed Mar 18, 2009 6:36pm EDT

1 of 2. A customer shops in the food section of a Target store in Arvada, Colorado, February 24, 2009.

Credit: Reuters/Rick Wilking

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WASHINGTON (Reuters) - U.S. inflation rose in February on higher gasoline and apparel prices, government data showed on Wednesday, indicating some pricing power in the recession-hit economy and easing fears of deflation for now.

In another snapshot of the U.S. economy, the country's current account deficit for the fourth quarter contracted sharply as imports fell more rapidly than exports.

But it was the Labor Department's Consumer Price Index that attracted the most attention. Analysts said that while the CPI data showed the risk of a persistent, broad decline in prices was fading, it did not indicate a resurgence of inflation, given the deep slump the economy is in.

In February, the overall CPI rose 0.4 percent, the biggest monthly gain since last July, and above January's gain of 0.3 percent.

"Kiss the idea of deflation goodbye. The brief foray into declining consumer prices over the winter seems to be over and done with," said Howard Simons, strategist at Bianco Research in Chicago.

About two-thirds of the rise in February's inflation rate came from the 8.3 percent jump in gasoline prices.

Compared with a year ago, consumer prices rose 0.2 percent after being flat in January. Core CPI, which excludes volatile food and energy prices, gained 0.2 percent in February, after rising at the same rate the prior month.

The Federal Reserve's announcement that it would buy up to $300 billion worth of long-term U.S. Treasuries to keep interest rates low and help revive an economy now in its 15th month of recession ignited a brisk rally in U.S. stocks and the prices of government bonds. Major U.S. stock indexes ended the session with gains of about 1 percent to 2 percent.

This will be the first time since the period from 1961 to 1965 that the Fed has bought longer-term U.S. Treasury securities.

The yield on the benchmark 10-year U.S. Treasury note had its biggest one-day drop since the stock market crash in October 1987. In late afternoon, the 10-year note's price was up 14/32, while its yield had tumbled to 2.51 percent from 3.01 percent at Tuesday's close.

But the U.S. dollar sank to a two-year low versus the euro.

Analysts said the Fed's latest move effectively left real interest rates negative across the board. The Fed kept the target for its benchmark overnight fed funds rate unchanged in a zero to 0.25 percent range.

APPAREL AND NEW VEHICLE PRICES JUMP

The February CPI data showed apparel prices up 1.3 percent, the biggest rise since a 1.5 percent gain in March 1990. Also contributing to the increase in the core inflation rate were new vehicle prices, up 0.8 percent, the largest advance since November 2004.

Compared with a year ago, core CPI rose 1.8 percent, creeping up from 1.7 percent in January, but still below the Fed's comfort zone of 2 percent.

Some analysts believe these gains in inflation were unlikely to be sustained, considering the economic slump and the accompanying surge in unemployment that is undermining consumer demand. They still see deflation as a risk.

"Even with energy prices having flattened out, the deflation risk is real," said David Greenlaw, an economist at Morgan Stanley in New York.

"Unless there is a powerful V-shaped recovery, which we deem highly unlikely, it is going to be several years before there is any legitimate reason to be concerned about a resumption of inflation risk."

Deflation is a broad-based decline in prices that can undercut an economy by leading consumers to hold off purchases in the hopes of even lower prices.

But some economists argue that the Fed's liquidity injections are expanding the money supply base and may ignite inflation going forward if the central bank does not deploy adequate measures to withdraw that money from the system once the economy recovers.

"The shoveling of money into the system eventually can start to push prices higher," said Bianco Research's Simons.

"Once the economy recovers, we will have some real problems because at that point, the banking system will start to turn this monetary base into credit and will lead to an explosion of money supply."

IMPORTS AND MORTGAGE RATES FALL

The anemic U.S. economy is causing a slump in domestic demand, which is crimping the appetite for imports.

Data from the Commerce Department showed the U.S. current account deficit for the fourth quarter contracted sharply to $132.8 billion -- the smallest since 2003's final quarter -- from $181.3 billion in the third quarter of 2008.

The current account, which covers goods, services and income transfers, is the broadest measure of total U.S. trade with the rest of the world.

The fourth-quarter current account deficit equaled 3.7 percent of gross domestic product, down from 5.0 percent in the third quarter, and the lowest since 3.4 percent in 2001's fourth quarter.

Earlier on Wednesday, the Mortgage Bankers Association reported that U.S. mortgage applications surged in the latest week, driven by a spike in demand for refinancing as the average rate on a 30-year fixed-rate home loan fell to 4.89 percent, matching a record low.

(Additional reporting by Doug Palmer in Washington and Lynn Adler in New York; Editing by Jan Paschal)