WASHINGTON -- It's getting a little ugly out there.
Wholesale price pressures are on the rise, threatening to spill over into a broad-based upturn in consumer prices, while the economy appears to be slowing down.
Evidence of rising inflation poked its unwelcome head into the bond market on Friday when the Labor Department reported that the producer price index in August surged 0.6% -- the biggest monthly gain since October 1990. The increase followed a chunky 0.5% increase in the July index.
The report was troubling, even taking into account special factors that boosted prices of some items such as tobacco, coffee, and gasoline, analysts said. "The direction seems to be toward higher prices," said Hugh Johnson, chief investment officer for First Albany Corp. "There's no question things are dark on the inflation side."
The report, which sent the yield on the Treasury's 30-year bond sharply higher to 7.70% in afternoon trading, came a week after an August unemployment report that was broadly read as signaling a slower pace of economic activity.
Analysts did not see any contradiction in a slowing economy and rising prices because price measures are viewed as a lagging indicator. Moreover, Federal Reserve officials have expressed confidence that their moves to tighten credit beginning in February are starting to cool housing and other sectors of the economy.
But the Labor Department report was a disappointment to the bond market because it suggested prices of crude and intermediate goods are on starting to stick to prices of finished goods sold by wholesalers. Increases in wholesale prices, in turn, could add to the widely watched consumer price index, due to be reported tomorrow.
At Chemical Securities Inc., analysts said they are now looking for a 0.5% rise in the August CPI.
The core rate for the PPI, which excludes food and energy, jumped 0.4% in August following a gain of only 0.1% in July and a drop of 0.1% in June.
Other price measures in the report excluding food and energy were up even more sharply. The core rate for intermediate goods, those one step below wholesale, surged 0.5%. The core rate for crude goods -- those that have not been processed at all --jumped 1.4% to produce a 12.4% increase compared with a year earlier.
"You're left with that sinking feeling, when you look at all the different components, that prices are a little more entrenched than you thought," Johnson said.
Federal Reserve vice chairman Alan Blinder said last week he believes the economy's growth rate is close to 2.5%, which is the pace that Fed officials believe can be sustained without triggering a rise in inflation. But Fed policymakers are expected to consider another round of rate increases when they meet Nov. 17, and Fed chairman Alan Greenspan has said they will be paying close attention to commodity prices and other forward-looking price measures.
Compared with a year ago, producer prices in August were up only 1.9%, as were prices excluding food and energy. "But the broad-based rise in some of these industrial prices indicates that there is still quite a lot of momentum in the industrial sector, and that is what fueled the market's plunge," said Lynn Reaser, chief economist for First Interstate Bancorp. in Los Angeles.
Reaser said Fed officials will be watching retail sales, inventories, and other reports over the next two months to see if the rate increases they have put in place so far are enough.
"They know their policies will act with a lag, but this is clearly a setback for them," Reaser said. "There is an actual acceleration in inflation, and the markets are raising a lot of inflation alarms."
However, not everyone believes inflation is getting out of hand in an economy that shows signs of slowing as a result of monetary restraint and tight federal budgets. Moreover, wage pressures, which account for most business costs, are still muted.
Mitchell Held, chief financial economist for Smith Barney Inc., said he does not believe companies will have much power to mark up goods in a slowing economy. And he said it is likely that Fed officials will tighten policy again.
"The worry about inflation is a valid one if you believe the Fed will not be up to the task. We believe it will be," said Held.