Inflation surges on record energy prices

Inflation accelerated in June to its fastest rate since the aftermath of Hurricane Katrina in 2005 while workers' earnings slumped, compounding the difficulties for policy-makers trying to support a weak economy without fueling price pressures.
Industrial output unexpectedly rose 0.5% in June, confounding expectations of no rise at all and following a fall in May, which might allay some concerns about a weak economy.
However, the Consumer Price Index, the government's key measure of inflation, advanced 1.1% during the month, the biggest monthly rise since September 2005, when Hurricane Katrina caused a spike in energy prices.
Compared with a year ago prices were up 5%, the biggest year-on-year rise since 1991. Coupled with data in the same report showing real weekly earnings fell 0.9% in June, it heightens fears the U.S. economy could be entering a stagflationary period of low growth and high inflation.
"The report underscores the stagflationary environment we are in right now, which is not good for the dollar," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto. "There is so much uncertainty in the market right now that news of higher inflation doesn't mean a rise in interest rates."
The data came ahead of Fed Chairman Ben Bernanke's second day of congressional testimony, in which he will appear before a House of Representatives panel at 10 a.m..
On Tuesday, he warned of downside risks to growth and the possibility of rising inflation. His focus on troubles in the financial sector and poor growth outlook led investors to pare bets on the possibility of Fed interest rate hikes this year.
Officials at the U.S. central bank have said they are keeping a close eye on inflation expectations.
The 5% annual inflation rate in Wednesday's data is very close to the 5.3% one-year inflation expectation in this month's Reuters/University of Michigan consumer sentiment report. However, Fed officials stress long-term expectations, which are currently running at 3.4%.
On Wall Street, stock futures opened flat after the CPI report. The dollar initially rallied then snapped back, while government bonds, which suffer during periods of inflation, fell.
U.S. mortgage applications rose for a third consecutive week, reflecting an increase in demand for home loan refinancing as interest rates plunged, an industry group said.
The report by the Mortgage Bankers Association provided a rare glimmer of hope for the housing sector, which is the origin of the economy's current malaise and source of turmoil in financial markets.
In more soothing news from the beleaguered financial sector, Wells Fargo & Co, the fifth-largest U.S. bank, reported better-than-expected quarterly results on Wednesday and raised its dividend despite a 23% decline in profit caused by a surge in bad loans.
The Treasury Department said net overall U.S. capital flows reversed sharply to show outflows of $2.5 bln in May after a revised inflow of $61.6 bln in April, which is a potentially troubling sign for the dollar if it were to continue.