PPI rise might hint at inflation Producer price index increase of 0.5% larger than expected

Investors are jarred

Chances are greater Fed will raise costs of borrowing

October 11, 1997|By BLOOMBERG NEWS

WASHINGTON -- Prices paid to U.S. factories, farmers and other producers rose a larger-than-expected 0.5 percent last month, jarring investors and suggesting the chances are greater the Federal Reserve will raise borrowing costs, government figures showed yesterday.

Higher prices for gasoline, tobacco and automobiles paced the largest increase in the producer price index since a 0.6 percent rise in December 1995, Labor Department said. In August, the PPI rose 0.3 percent -- the first increase of the year -- after a post-World War II record of seven consecutive monthly declines.

"Maybe you're getting the first taste of inflation, though you're not getting a major upswing in labor costs," said Cary Leahey, chief U.S. economist at High Frequency Economics Ltd. In Valhalla, N.Y.

Stocks and bonds slumped as investors grappled with the possibility that the rise in producer prices may signal the start of an inflationary surge that in turn could prompt Federal Reserve officials to push up borrowing costs.

Fed Chairman Alan Greenspan contributed to investor anxiety earlier this week when he warned that low unemployment and worker shortages could push labor and production costs higher -- reversing recent inflation trends. "The law of supply and demand has not been repealed," he told Congress.

Investors who believe rates won't go up, or might go down, are "insanely disrespectful" of the economy's fundamentals, said a Fed official who is privy to both Greenspan's thinking and the deliberations of the policy-making Federal Open Market Committee.

"The decision going forward is [whether] to hold [rates steady] or to tighten," said the Greenspan associate. Rates will be

pushed higher if the robust U.S. economy continues to steam ahead, squeezing labor markets tighter, forcing wages up and straining productive capacity, he said.

In financial markets, the Treasury's benchmark 30-year bond dropped nearly a point, pushing up the yield seven basis points to 6.42 percent. The Dow Jones Industrial Average fell 16.21 points to close at 8,045.

Some analysts said investor reaction to Greenspan's remarks and yesterday's PPI report relaxes pressure on the Fed to raise borrowing costs. Greenspan "threw needed cold water on the markets," said Diane Swonk, deputy chief economist at First Chicago, NBD. "Will the bond market deliver the Fed from tightening? They probably will."

Most analysts said the inflation signals in yesterday's PPI report might be overstated. "None of this stuff is alarming," said Hugh Johnson, chief investment officer at First Albany Corp. in New York. "If you look at prices over the last six months, you'll see the big picture shows only some modest upward pressure on prices."

While government figures showed that passenger car prices rose a seasonally adjusted 1.4 percent in September, car prices actually fell 1.8 percent without seasonal adjustments. Merrill Lynch & Co. economists said automakers began discounting 1998 models earlier than usual this year, which led to the seasonal-adjustment quirk in the September PPI.

Moreover, when the effects of one-time rises in tobacco and auto prices, along with often-volatile food and energy prices, are excluded, the core rate rose just 0.1 percent in September, according to a Labor Department spokesman, a sign most prices remain well behaved.

"This obviously is a one-month wonder," said Robert Dederick, an economic consultant at Chicago's Northern Trust Co.

For the first nine months of 1997, producer prices have fallen at an annual rate of 1.4 percent, compared with a 2.5 percent increase posted for the same period in 1996.

Pub Date: 10/11/97

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