WRAPUP 3-U.S. producer prices tame but gain in core vexes

(Updates with closing market levels)

* 12-month core producer price gain is biggest since 1991

* April PPI up 0.2 percent, core up 0.4 percent

* Bigger-than-expected core price gain hits stocks

* Spike in pipeline inflation problem for Fed

By Alister Bull

WASHINGTON, May 20 (Reuters) - U.S producer prices excluding energy and food rose at their fastest pace since 1991 in the year to April, highlighting inflation concerns that may limit the Federal Reserve's options to support a weak economy.

The Fed -- the U.S. central bank -- has been counting on slower growth to stop soaring fuel and food costs spilling into wider inflation but data released on Tuesday on prices paid at the farm and factory gate suggest that battle is not yet won.

The Labor Department said the Producer Price Index rose 0.2 percent last month as food prices took a respite from their march upward and as gasoline costs, which usually climb sharply in April, fell after adjustment for seasonal swings.

However, core producer prices, which strip out volatile energy and food costs, increased by 0.4 percent -- twice the rate forecast on Wall Street.

Over the past 12 months, core prices have risen 3 percent, the largest gain since December 1991. Overall producer prices were up an even stiffer 6.5 percent.

U.S. stock prices fell as investors, already alarmed by a fresh record oil price CLc1 notched on Tuesday near $130 per barrel, took further fright over the high core price gauge.

The Dow Jones Industrial Average .DJI closed down almost 200 points or more than 1.5 percent in New York.

"Nothing here bodes well for consumers," said Joel Naroff, president at Naroff Economic Advisors in Holland, Pennsylvania, adding: "It's putting more pressure on businesses to raise their costs. This is problematic in an economic slowdown."

Soaring energy costs have buoyed producer prices and spilled into broader measures of inflation in a worrying fashion for the Fed, which has slashed benchmark interest rates by 3.25 percentage points since mid-September to buffer the economy from a lingering housing crisis and credit crunch.

Fed Vice Chairman Donald Kohn said in New Orleans on Tuesday rising inflation expectations were a concern but that the economy was still dogged by the housing slump, creating a high level of uncertainty that demands policy flexibility.