Inflation gauge ticks up as trade gap narrows

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.

The June deficit was below the median forecast of $61 billion from Wall Street analysts polled by Reuters.

Overall goods and services exports rose 1.5 percent from May to a record $134.5 billion, led by a $1.2 billion increase in industrial supplies and materials and record exports of vehicles, auto parts and engines and of foods, feeds and beverages.

Rising U.S. exports are contributing to a narrowing of the trade gap on an annual basis and are helping to underpin domestic growth in the face of a steep housing downturn and credit market turmoil.

Some analysts said the trade data would result in an upward revision to U.S. gross domestic product growth, to 4 percent or more for the second quarter from an initially reported pace of 3.4 percent.

"It was a big month for exports, and that ties in with the strength in corporate profits we've seen," said Societe Generale chief U.S. economist Stephen Gallagher.

"I think there has to be some recognition that the economy is probably stronger than we thought and has a greater foundation to absorb this latest liquidity trap," he said. "If it weren't for this liquidity issue in the markets, the Fed would see this as a strong signal that reinforces their policy decision" to hold rates steady.

U.S. imports in June rose 0.5 percent to a record $192.7 billion as the U.S. oil import bill edged higher to $19.6 billion and imports from China increased.

The average price for crude oil rose $1.59 a barrel to $60.95, the highest since $62.40 in September 2006. Imports from the Organization of Petroleum Exporting countries, however, decreased 4.6 percent to $13.9 billion.

The politically sensitive U.S. trade deficit with China widened 5.7 percent in June to $21.2 billion, despite record exports of $5.9 billion to China. Imports from China rose 6.8 percent or $1.7 billion to $27.1 billion, the highest since November 2006.

China last week reported that its own global trade surplus edged lower in July to $24.36 billion from a record $26.91 billion in June as rebates of value added taxes were eliminated on July 1 for 2,800 export product lines.

Separately, a survey from the Federal Reserve Bank of Philadelphia showed that forecasters trimmed their estimates for third-quarter U.S. growth, to 2.5 percent from a pervious forecast of 2.6 percent.