Inflation in check in July but August outlook weaker

By David Lawder

WASHINGTON (Reuters) - Inflation was under control in July and U.S. factories were busier than forecast, according to economic data released on Friday, but other reports showed U.S. consumer sentiment worsened in August and the outlook for economic growth weakened.

Markets and analysts, however, mostly shrugged off the data, focusing instead on a speech by Federal Reserve chief Ben Bernanke and on President George W. Bush's announcement of proposals to help bail out some troubled subprime borrowers so they can keep their homes.

Bernanke said the Fed will take the necessary steps to shelter the economy from turmoil in financial markets but will not bail out investors who made mistakes.

"The committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets," Bernanke said in a speech to a symposium in Jackson Hole, Wyoming, organized by the Kansas City Federal Reserve.

Bush said the Federal Housing Administration would launch a new initiative to make it easier to allow homeowners who can no longer afford mortgage payments that have reset higher to refinance their loans. The change would allow more borrowers with good payment histories to switch into FHA-insured loans.

Bush also pledged to redouble efforts to persuade Congress to approve FHA reform, which could make the program once again relevant in high-priced coastal housing markets, where many buyers turned to adjustable-rate and non-traditional mortgages.

Wall Street stocks climbed on the Bush plan and on Bernanke's remarks, which many investors viewed as a tilt toward a possible interest rate cut in September. U.S. Treasury debt prices fell as they lost some of their safe-haven bid.

JULY DATA GOOD, AUGUST WORRISOME

Core U.S. consumer prices edged up less than expected in July while income and spending rose smartly and factory orders far exceeded forecasts, according to government reports.

A core inflation index from the Commerce Department rose 0.1 percent in July, holding the year-on-year increase in the Federal Reserve's favorite inflation gauge to 1.9 percent for the second straight month.

Analysts polled by Reuters were expecting the core PCE price index, which excludes often-volatile food and fuel costs, to gain 0.2 percent. The June rise was revised to 0.2 percent, from an originally reported 0.1 percent.

"It doesn't seem like pricing pressures are moving out of control," said George Davis, chief technical strategist at RBC Capital Markets in Toronto.

Although analysts said the benign inflation data provides some latitude for the Fed to cut the federal funds rate to forestall a credit crunch, the other data suggested that the economy may not need such stimulus.

"Ben Bernanke continues to emphasize that, away from housing, the economy continues to expand at a moderate pace," said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey.

On a more worrisome note, a Reuters/University of Michigan survey of consumer sentiment index fell to the lowest level in 12 months as households grew uncertain about economic prospects due to high food and fuel prices and recent financial market turmoil.