Producer prices jump, housing starts at 1991 low

By Alister Bull

WASHINGTON (Reuters) - Soaring energy costs pushed U.S. producer prices up sharply last month and housing starts fell to 17-year low, according to data on Tuesday that spotlighted the dilemma the Federal Reserve's faces in trying to tackle weak economic growth amid high inflation.

Producer prices rose by a larger-than-expected 1.4 percent in May as energy prices leaped 4.9 percent, but core inflation at the producer level slowed as forecast, as car prices sank, a Labor Department report showed.

The U.S. dollar slipped on the tame core inflation data and speculation the Federal Reserve will be in no hurry to raise interest rates while economic growth remains fragile.

Similar thinking helped U.S. government bond yields to fall, while Wall Street stocks slipped on worry over bank earnings.

"We have very weak housing with no sign yet of a turnaround and meanwhile rising food and energy costs are boosting wholesale inflation," said Gary Thayer, senior economist at Wachovia Securities in St. Louis.

Economists had expected the Producer Price Index, a gauge of prices paid at the farm and factory gate, would rise 1.0 percent after increasing 0.2 percent in April.

Over the 12 months through May, producer prices have risen 7.2 percent, marking the eighth consecutive month in which prices rose more than 6.0 percent on a year-on-year basis, the longest stretch since the stagflationary period that ended in 1982, a Labor department official said.

"There is nothing here to breed complacency at the Fed or for that matter (investors') risk appetite," said Alan Ruskin, chief international strategist, at RBS Global Banking and Markets in Greenwich, Connecticut.

"There is a strong argument that either producers find some pricing power and hike prices which forces Fed action, or they have little pricing power and take the hit on profit margins."

The U.S. central bank has cut its key interest rate 3.25 percentage points to 2.0 percent since mid-September to shield the economy from a collapsing housing market.

It has signaled it will now go on hold while it watches economic growth and inflation, and expects price pressures to ease in the months ahead.

Core producer prices excluding energy and food increased by 0.2 percent, as expected, slowing from a 0.4 percent gain in April. Core prices were up 3 percent from a year ago, matching the April gain as the biggest increase since 1991.

Signaling pressures at an earlier stage in the production process, "core intermediate" goods prices rose 2.0 percent last month for the largest rise since January 1980. This included a record 10.7 percent increase in steel mill product prices.

Gasoline prices at the producer level rose 9.3 percent in May to stand 26.3 percent above their year-earlier level.

"I think we have a little bit of inflation but certainly not runaway inflation. The inflation story would fade quickly if oil pulls back below $120 per barrel," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis.