October 17, 2007 / 1:30 PM / 12 years ago

WRAPUP 3-U.S. housing starts skid, inflation flares

(Updates with Fed’s Beige Book, paragraph 9-11; updates interest rate futures, paragraph 15)

By Patrick Rucker

WASHINGTON, Oct 17 (Reuters) - Groundbreaking for new U.S. homes and permits for future building both hit a 14-year low last month, reviving worry about a deepening housing slump and prompting investors to boost bets on interest-rate cuts.

Housing starts tumbled 10.2 percent to a 1.191 million unit annual rate, the slowest since March 1993, the Commerce Department said on Wednesday. Economists had expected starts to slip, but the sharpness of the downturn took them by surprise.

“There is no end in sight,” said Kurt Karl, chief U.S. economist with Swiss Re in New York. “The builders didn’t realize how many cancellations they are going to face. If we hit 1.0 million start range, it’s consistent with recessions in the past. And we are heading in that direction.”

The dour report pushed up prices for bonds and weighed on the dollar as traders saw greater likelihood the Federal Reserve would follow up a rate cut it made last month with another at its next meeting on Oct. 31.

A separate report, however, showed the economy facing inflation pressure from food and energy, which could complicate the Fed’s thinking on borrowing costs.

The Labor Department said the Consumer Price Index, the most broadly used gauge of inflation, rose 0.3 percent last month, the biggest gain in four months. However, the core rate, which excludes energy and food, moved up a modest 0.2 percent.

“The housing starts and consumer price inflation numbers highlight the tough dilemma the Federal Reserve faces,” said Bernard Bauhmohl, managing director of the Economic Outlook Group in Princeton Junction, New Jersey.

“Both of its mandates —- averting recession and controlling inflation —- are now being challenged,” he said.

A survey of business contacts conducted by regional Federal Reserve banks to help prepare for the Oct. 31 interest-rate meeting found U.S. economic growth has slowed since August, with consumers pulling back a bit and housing falling further.

The report, known as the Beige Book for the color of its cover, also found businesses were facing higher production costs, although some had not yet responded by charging higher prices to consumers.

“The ability to pass higher input costs to selling prices was mixed.” the Beige Book said. “Competitive pressures are restraining retail price increases in many instances.”

BIGGEST RISK

U.S. Treasury Secretary Henry Paulson on Tuesday identified housing as “the most significant current risk” to the economy, while Fed Chairman Ben Bernanke said on Monday the sector would be a significant drag into next year.

Indeed, the Commerce Department said permits for future building fell 7.3 percent last month, the sharpest drop since January 1995, to an annual rate of 1.226 million, the lowest level since July 1993.

A separate report on Wednesday showed mortgage applications rose for a second straight week, but some analysts said that was a sign potential borrowers were being turned down for loans and were applying more frequently.

The weak tenor of the housing data and Beige Book led interest rate futures markets to price in a 56 percent chance that the Fed, which slashed benchmark borrowing costs by a surprisingly large half-percentage point to 4.75 percent last month, would lower them again by a quarter-point on Oct. 31. Late yesterday, futures prices implied only a 38 percent chance of a rate cut.

Still, rising fuel and food costs could restrain the Fed. Food prices rose 0.5 percent last month, while energy costs increased 0.3 percent.

In addition, oil prices hit a record $89 a barrel on Wednesday, increasing worries that inflation will move higher and hinder economic growth.

Over the past 12 months, consumer prices have risen 2.8 percent, the largest year-on-year gain since March. Core prices were up 2.1 percent, the same as in August when the year-on-year gain eased to a nearly 1-1/2 year low. (Additional reporting by Glenn Somerville)

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