Shares fall as surge in US inflation sparks rate fears

AN UNEXPECTED surge in inflation in the United States sparked fears of an imminent rise in interest rates, sending shares plunging in New York and across Europe.

Consumer prices rose 0.7 per cent last month - the fastest rate for almost a decade - on the back of sharp increases in the prices of petrol, clothing and tobacco.

But the core figure that excludes these volatile factors also picked up sharply, rising 0.4 per cent compared with a 0.1 per cent gain in March and a forecast of 0.2 per cent.

The increase was the steepest of the eight-year economic miracle, marring a near-perfect inflation picture and raising tension levels ahead of next week's meeting of the Federal Reserve to discuss rates.

The Dow Jones reacted quickly, dropping 170 points within minutes, while in London the FTSE 100 closed down 156.2 or 2.4 per cent at 6,300.4.

The White House moved to calm fears, saying inflation remained at historically low levels in spite of April's increase. "The figure was slightly above what the market expected but it was mostly based on tobacco and oil," said a spokesman.

Petrol rose 15 per cent, propelling energy prices up 6.1 per cent, the steepest rise since records began in 1957. Tobacco prices were up 3.6 per cent, clothing rose 1.5 per cent, its sharpest pick-up since 1990, and airline fares were ahead 2 per cent.

Economists said the Federal Reserve would adopt a "bias" towards tightening monetary policy while some insisted a immediate hike in rates was on the cards.

John Lonski, of Moody's Investors Service in New York, said: "We could be looking at a stronger world economy joining an already robust US pace of activity that can only point towards increased inflation risks and higher interest rates in the months ahead." Bernard Jensen, managing director of Fuji Securities, said: "It puts the Fed back into play again and I would have to assume they're going to adopt a bias to tighten if in fact they don't tighten."

But Ian Shepherdson, of High Frequency Economics, said the market had expected higher fuel inflation on the back of the recovery in oil prices. Retailers had put up prices of clothing and tobacco after months of discounting, he added. "It is ridiculous to argue this is the start of an inflationary surge. The markets simply chose to believe the previous figures were permanent."

There was more concern for the Fed from strong industrial output data for April, confirming a rebound in the manufacturing sector. Total industrial output climbed 0.6 per cent last month, the strongest since a 1.4 per cent jump in August. The price of the benchmark 30-year US Treasury bond tumbled two points and its yield hit the highest level for a year. The bond yield touched 5.90 per cent at the height of the sell-off, its highest level since May 1998.

The markets were taken by surprise after data released this week indicated inflationary pressures were almost non-existent in the US economy.

Earlier this month Fed chairman Alan Greenspan warned the "truly phenomenal" economic performance could not last forever.