WASHINGTON - Led by higher gasoline prices, consumer inflation shot up in November by the largest amount in more than two years.
The rise in inflation is coming at a time when economic growth is slowing sharply.
"We are in store for a period of very weak if not recessionary growth and uncomfortably high inflation," said Mark Zandi, chief economist at Moody's Economy.com. "People are going to get hit with both a weaker job market and having to pay more to fill their gas tanks and buy groceries."
The Labor Department report yesterday showed its closely watched consumer price index rose 0.8 percent last month, the biggest gain since September 2005, as energy prices surged 5.7 percent, reflecting a big gain in gasoline. Core inflation, which excludes energy and food, was also up last month, rising 0.3 percent as the cost of clothing, airline tickets, and prescription drugs all took big jumps.
The bad news on inflation sent stock prices lower yesterday as investors worried that rising prices will keep the Federal Reserve from cutting interest rates quickly enough to keep the country out of a recession. The Fed uses lower interest rates to stimulate a weak economy and higher rates to slow growth and keep inflation in check.
The Dow Jones industrials fell 178.11 points to 13,339.85. With the economy slowing at the same time that inflation is rising, the Fed could face a tough policy dilemma similar to the problems it faced in the 1970s when a series of oil shocks sent inflation soaring at the same time the country was struggling with weak economic growth. The combination of stagnant growth and inflation got branded as "stagflation."
The report on consumer prices followed one Thursday showing inflation at the wholesale level jumped an even larger 3.2 percent in November, the biggest increase in 34 years.
The Fed cut a key interest rate by a quarter-point on Tuesday but failed to give a strong signal about future cuts, which sent the Dow average plunging 294 points. However, investors were encouraged when the Fed on Wednesday joined with other central banks around the world to unveil initiatives designed to combat a serious global credit crunch that is weighing on economic activity as banks cut back on their lending.
Despite the higher inflation, many economists said they still believe the Fed will keep cutting interest rates because of the severity of the credit crunch.
"The danger associated with what is playing out in the credit markets will dominate the Fed's attention in the coming year," said Jim Glassman, senior economist at JPMorgan Chase & Co.
Lyle Gramley, a former Fed governor, now an economist with the Stanford Financial Group, said there was a danger the Fed could respond too slowly because of a split among policy makers. Federal Reserve chairman Ben "Bernanke and others see an economy that is in danger of falling into a recession because of the credit crunch, but if you read the public speeches of some of the regional bank presidents, you would hardly feel there is anything wrong with the economy. They are very hawkish on inflation," Gramley said. Several bank presidents have delivered speeches recently emphasizing the need to fight inflation.
With one month to go, inflation in 2007 is rising at an annual rate of 4.2 percent, far above the 2.5 percent increase in 2006. The acceleration has been driven by energy prices, which are rising at an annual rate of 18.1 percent this year, compared to an increase of 2.9 percent in 2006.