Two worrisome trends for the economy — falling house prices and the rising cost of everything else — picked up speed in data...

Share story

Two worrisome trends for the economy — falling house prices and the rising cost of everything else — picked up speed in data reported on Tuesday, putting Federal Reserve policymakers in an increasingly tough position.

If they move too aggressively to cut interest rates and stimulate the economy, they might stoke inflation at a time when consumers are already squeezed by higher prices for food, energy, clothing and other goods. But if they chose more austere measures, the economy may weaken substantially faster.

“The Fed is now having to walk a very fine line,” said Jane Caron, chief economic strategist at Dwight Asset Management, an investment firm that specializes in bonds. “We have clearly seen an acceleration in inflation pressure in the last couple of months, and the risk is that the markets are going to react negatively to aggressive easing going forward.”

The central bank cut its target for the federal-funds rate, the interest that banks charge each other, by 1.25 percentage points in January, the biggest one-month move in a quarter century, as it stepped up efforts to keep the weakening economy from falling into a recession.

Fed Chairman Ben Bernanke is scheduled to deliver the Fed’s twice-a-year economic report to Congress today and Thursday. Financial markets are watching closely to see whether Bernanke signals further rate cuts will be likely, given a string of weak economic reports, or whether he will raise concerns about a jump in inflation that occurred in January, which could mean the Fed is rethinking the pace of its rate cuts.

The Labor Department reported Tuesday that wholesale prices, which exclude taxes and distribution costs, rose 1 percent in January, up from a drop of 0.3 percent. Compared with a year ago, prices were up 7.4 percent. Excluding volatile food and energy prices, the so-called producer price index was up 2.3 percent from a year ago, up from 2 percent in December.

The latest inflation report appears to corroborate a broader trend of higher prices across the economy. Last week, the Labor Department reported elevated readings for consumer prices. The consumer price index was up 4.3 percent last month from a year ago, up from a 4.1 percent increase in December.

To be certain, the core rate of inflation — which excludes food and energy — remains closer to the Fed’s target of 1 percent to 2 percent. Core consumer prices were up about 2.5 percent in January, up from 2.4 percent in December.

“Months of surging energy prices appear now to be trickling up the production chain to finished-goods prices,” Kenneth Beauchemin, an economist at Global Insight, a research firm, wrote in a note to clients.

Not surprisingly, the drumbeat of negative economic data appears to be taking a toll on consumers — at least in the way they perceive the economy, if not in how they spend.

The Conference Board reported on Tuesday that its consumer confidence index fell to a reading of 75 this month, from 87.9 last month. The index was last at this level in early 2003 at the start of the war in Iraq and a time when the economy was growing but unemployment rate was hovering just below 6 percent. By contrast, the unemployment rate was 4.9 percent in January. The index uses 1985 as measuring 100.

“February may go down in history as the month that the previously indefatigable U.S. consumer finally threw in the towel, beaten by a combination of deteriorating labor market conditions, surging prices for food and energy and collapsing house prices,” Paul Ashworth, a senior U.S. economist at Capital Economics, wrote in a note to clients.

The Fed’s rate cuts have helped reduce some of the strains in the financial market but they have been less successful in lowering borrowing costs and easing lending standards for businesses and consumers.

In the past several weeks, mortgage interest rates have risen sharply as bond investors have grown more risk-averse. The national average interest rate on a 30-year fixed-rate mortgage rose to 6.04 percent last week, from a low of 5.48 percent in early January, according to Freddie Mac, the government-sponsored buyer of mortgages.