Inflation gathers steam as housing slides

WASHINGTON (Reuters) - A steady rise in U.S. consumer prices in January pointed to persistent inflation pressures despite fresh signs on Wednesday that the declining housing sector remains a drag on the economy.

The Consumer Price Index, a broadly based gauge of U.S. inflation, rose a faster-than-forecast 0.4 percent for a second straight month and was up a steep 4.3 percent in the 12 months through January, a Labor Department report showed.

Separately, the Commerce Department said permits for new building fell 3 percent last month to the lowest in 16 years while starts on new homes rose only slightly.

"It is by no means self-evident that a slowdown in the U.S. economy will hold down inflationary expectations at a time of rising commodity costs," said economist Roger Kubarych of UniCredit Global Research in New York.

The Federal Reserve later lowered its estimate for U.S. economic growth in 2008 to a range of 1.3 percent to 2 percent from 1.8 to 2.5 percent that it had foreseen last November.

It cited "an especially worrisome possibility" that economic weakness may feed on a contraction in credit and thus further undermine growth.

Financial services firm UBS, in a research report issued on Wednesday, said it considered that a mild recession already has begun in the United States.

IT'S HERE, NOW

"It's not coming, it's here," UBS said.

The Fed, the U.S. central bank, has been aggressively cutting the benchmark federal funds interest rate, bringing it down to 3 percent from 5.25 percent in mid-September to bolster the economy against a housing downturn and a pinch in credit.

Stock prices fell after the unfavorable prices data was published but recovered later on the back of stronger prices for technology stocks after computer maker Hewlett-Packard Co reported heftier profits.

The Dow Jones industrial average added 90.04 points or 0.73 percent to end at 12,427.26 while the high-tech-laden Nasdaq Composite Index rose 20.90 points or 0.91 percent to end at 2,327.10.

Bond prices were mixed. Investors sought safe haven in U.S. Treasuries in the morning but returned to equities in the afternoon when computer stocks began to rise.

The bellwether 10-year Treasury note rose 3/32 in price and yielded 3.90 percent while the two-year note was down 4/32 and yielded 2.14 percent. Bond prices and yields move inversely.

In a speech in Kirksville, Missouri, St. Louis Fed President William Poole said that while the U.S. central bank must try to nurture growth, it should not do so at the cost of permitting inflation to get out of control and wreak havoc.

"A substantial increase in the rate of inflation promises a larger recession later, as the country learned at such great cost in the 1970s," Poole pointed out.

Not only was the headline CPI higher in January, but so were closely watched core prices, which exclude food and energy costs. Core prices rose 0.3 percent, the strongest increase for any month since June 2006.

For the 12 months through January, core prices were up 2.5 percent compared with 2.4 percent a month earlier. It was the largest 12-month gain since March and a pace that is likely to make Fed officials uncomfortable.

INFLATION FLAG WAVING

"This is going to raise the flag on the inflation front, but it's not going to take away the front-end action from the Fed to support growth," said Lindsey Piegza, a market analyst with FTN Financial in New York.

Price increases were widespread, with food costs notably higher. Food prices jumped 0.7 percent, the largest rise since last February, after being up a scant 0.1 percent in December.

That offset an easing in the pace of energy price rises, which were up 0.7 percent last month after climbing 1.7 percent in December.

The CPI and housing starts reports underlined the economic difficulties at the beginning of the year as the Bush administration sought to shore up the economy with a $152 billion fiscal stimulus plan and the Fed lowered benchmark interest rates to try to spur growth and lending.

"I do worry that Fed claims of (inflation) expectations remaining anchored will go the way of claims that the subprime mess was contained," commented Joseph Brusuelas, chief U.S. economist for IDEAglobal.

New U.S. housing permits slipped to a 1.048 million annual rate, the weakest since November 1991. Permits are an indicator of builder confidence in future housing activity.

Starts rose to a 1.012 million unit annual rate, a slight rebound from the revised 1.004 million pace in December, which was the lowest since May 1991.

In more dour housing news, U.S. mortgage applications plunged last week, with loan demand hitting the lowest since the start of the year as interest rates surged, according to the Mortgage Bankers Association.

(Additional reporting by Mark Felsenthal and David Lawder in Washington, Alister Bull in Kirksville, Missouri and Burton Frierson in New York; Editing by James Dalgleish)