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inflation out of control GLOBAL ECONOMY-Inflation rates spike, central banks warn
Tuesday 18 October 2005, 4:56pm EST


By Mike Dolan, Economics Correspondent

WASHINGTON, Oct 18 (Reuters) - Record fuel costs pushed inflation higher across the world last month, reinforcing warnings from central banks that interest rates may need to rise further to stifle more broad-based wage and price gains.

A rash of data over the past week showed headline inflation rates spiking to their highest in more than a decade in the United States and to multi-year highs in Europe too.

Inflation rates that strip out highly volatile energy and food prices remain much more modest.

But policy-makers are anxious about the prospect that persistently high oil prices and overall inflation rates may start to nudge up wage demands and alter market and household psychology by embedding expectations of higher inflation.

"One option that is clearly not on the table is allowing an unacceptable rise in inflation," said San Francisco Federal Reserve Bank chief Janet Yellen, echoing a chorus from of the Fed policy-makers in recent weeks.

U.S. producer prices, prices received by farms, factories and refineries, rose 6.9 percent in September from a year earlier, the biggest increase since November 1990 when the Iraqi invasion of Kuwait three months earlier sent oil soaring.

Data on Friday showed annual consumer price inflation at a 14-year high of 4.7 percent in September.

Eurostat said on Tuesday that euro-zone consumer prices accelerated to a 4-year high in September of 2.6 percent -- well above the European Central Bank's preferred 2 percent ceiling. And the Bank of England had to digest news of a 2.5 percent gain in consumer prices -- the highest gain since UK consumer price records began in 1997.

To be sure, soaring fuel prices -- in part due to last month's U.S. oil industry outages after two devastating hurricanes -- are exaggerating all headline inflation rates.

But if crude oil prices do not retreat, there are growing concerns these headline inflation rates will start to feed into other consumer and producer prices and into wage demands.

"Global central banks are sending a remarkably unified warning about the threat to core inflation from high energy prices and more have begun to tighten policy," said David Hensley, global economist at JP Morgan in New York.

TOUGH TALK

Several U.S. Federal Reserve officials have indicated in recent weeks that benchmark short-term U.S. interest rates -- already up 2.75 percentage points to 3.75 percent in the past 15 months -- are headed even higher to prevent a build-up of much-feared inflation expectations.

European Central Bank officials have also warned that euro zone rates -- at 2 percent for more than two years -- will also rise if wage pressures build or core inflation climbs.

ECB President Jean Claude Trichet said on Tuesday the bank would "act decisively" on signs of second-round effects from headline inflation. Chief economist Otmar Issing echoed that.

"We have never left any doubt that we will act if we see that over the medium term inflation is threatening to run out of control," Issing told German magazine Euro.

The Bank of Canada was the latest of the Group of Seven rich nation central banks to act rather than talk.

On Tuesday, it hiked rates a quarter percentage point to 3 percent, the second rise in 2 months as it tries to keep inflation there within its target range.

In Asia, the Bank of Japan is closely monitoring the likely re-emergence of inflation after years of aggregate price declines and markets are speculating about the timing of its exit from a super-easy money policy with zero interest rates.

South Korea's central bank raised its key interest rates for the first time in three years last week. The Bank of Thailand is widely expected to raise rates on Wednesday for the eighth time in little over a year.

INFLATION IN CONTEXT

In a speech in Tokyo earlier on Tuesday, outgoing Fed chief Alan Greenspan struck a calmer note on inflation than many of his policy-making colleagues.

"The effect of the current surge in oil prices, though noticeable, is likely to prove significantly less consequential to economic growth and inflation than the surge in the 1970s."

And there are some analysts who say the Fed and ECB are trying to drum inflation expectations out of the system by talking -- not necessarily acting -- tough.

Markets have braced for weeks for both the news of these inflation spikes and the potential central bank response.

Gold -- seen traditionally as a hedge against the erosion of paper money from rising inflation -- hit an 18-year high at $480.25 per troy ounce last week, but has slipped since.

Yields on government bonds, which discount future inflation and future interest rates, have risen sharply over six weeks.

But inflation expectations embedded in those markets -- calculated by comparing 10-year yields with those of equivalent inflation-protected securities -- remain low.

U.S. 10-year expectations remain modest at about 2.6 percent and euro zone equivalents remain just under 2 percent.

And it is the desire to maintain that credibility in central banks keeping inflation at bay over the longer term that may spur policy-makers to act sooner rather than later.

"That legacy is our principle challenge," New York Fed chief Timothy Geithner said on Tuesday.

(Additional reporting by Ros Krasny and Victoria Thieberge, Tim Ahmann, Gilbert Le Gras and Stella Dawson)