Inflation gauge ticks up as trade gap narrows

By David Lawder

WASHINGTON (Reuters) - Rising energy costs drove up U.S. producer prices last month, while the trade deficit unexpectedly narrowed in June on stronger exports, according to reports on Tuesday suggesting the Federal Reserve will remain cautious about cutting interest rates.

The Fed in recent days has been pumping cash into credit markets roiled by fears over the spreading impact of subprime mortgage defaults. But any fresh evidence of inflation or a resilient economy will likely deter the Fed from considering a rate cut, analysts said.

Producer prices -- a measure of the prices paid at the farm and factory gate -- rose 0.6 percent in July, the Labor Department said. Economists polled by Reuters forecast producer prices would rise 0.2 percent last month.

"This report won't alter the Fed's concern about upside risks to inflation. But in light of the growing turmoil in credit markets, the risks to the economy are also piling up," said Sal Guatieri, senior economist at BMO Capital Markets in Toronto.

The Fed said last week that inflation remained its predominant concern, although it acknowledged that credit conditions had tightened for some households and businesses. The central bank showed concern over the fragile financial system by pumping billions of dollars of credit into the banking system in recent days.

Underlying data suggested inflation, while still a concern, was in line with recent trends. Stripping out food and energy costs, producer prices advanced 0.1 percent, even less than the 0.2 percent increase that economists had forecast.

While some analysts welcomed the lower-than-expected core inflation number, others said it was not enough to keep the year-on-year core rate from rising to 2.3 percent.

"While it seems so far that higher commodity prices have not been spilling over to prices of other consumer goods, we remain convinced this development threatens a broader pickup in inflation," said Harm Bandholz, economist at UniCredit Markets in New York.

A clearer picture will emerge on Wednesday when the Labor Department issues consumer price data for July.

Investors initially reacted positively to the data, sending Treasury debt prices lower, but credit worries took hold of the markets again after several Canadian investment trusts disclosed trouble repaying short-term loans. Wal-Mart Stores Inc. (WMT.N) issued a profit warning, spreading fears that the housing downturn was finally denting consumer spending.

This sent Treasury prices higher and yields lower, while the battered dollar rose to a 1-month high as investors rolled back bets against the greenback. Stocks tumbled sharply, with the Dow Jones industrial average .DJI falling 207 points to its lowest close since April 24.

Wal-Mart, the world's biggest retailer, said many of its customers were "running out of money toward the end of the month," suggesting household budgets were strained.

When consumers are feeling cash-strapped, Wal-Mart's stores typically show a twice-monthly spike in sales around the time when most people receive paychecks. Business tails off at the end of the paycheck cycle.

EXPORT SURGE

The U.S. trade deficit unexpectedly narrowed in June as a weaker dollar and overseas growth boosted exports to a record. The June trade gap totaled $58.1 billion, down 1.7 percent from a downwardly revised May deficit of $59.2 billion, the Commerce Department said.