US producer prices show inflation under control: Markets relieved by reduced chance of interest rate rise

NERVOUS financial markets received a reassuring surprise yesterday, with the news that US producer prices fell last month. Latest government figures suggest that despite a strengthening economy, core inflation is well under control - which in turn sharply lessens the chances of an increase in interest rates by the Federal Reserve.

The Labour Department's announcement of a 0.2 per cent decline in the closely watched index was greeted with immediate rises in stock and bond prices on Wall Street, where expectations were of an increase in October of around 0.2 per cent.

Although the outcome was artificially improved by a quirk in the way the department calculates new car prices at the start of a model year, October was the fifth month out of six in which producer prices either fell or held steady. On an annual basis, the index is showing a rise of just 0.4 per cent, compared with 1.6 per cent in 1992.

'This is an excellent result, whichever way you look at it,' said Stephen Roach of the Morgan Stanley investment bank. 'There is no inflationary pressure anywhere in the system.'

Today, however, brings a new test of the market's nerves, with the scheduled release of the consumer price index for last month. Although the CPI too is rising at only a modest rate - 2.7 per cent over the past 12 reporting months - the new 4.3 cents a gallon petrol tax increase, part of last summer's deficit- cutting budget package, is likely to have a big impact.

Most analysts are braced for a CPI rise of perhaps 0.5 per cent in October. But even so, few economists believe this will persuade the Fed to raise short-term rates when its policymaking Open Market Committee meets next week.

A string of encouraging indicators over the past two weeks has begun to convince markets that after a long period of near stagnation, the economy is poised for steady growth of 3 per cent or more, until the end of 1994.

However, next week's crucial congressional vote on the North American Free Trade Association remains a deep worry. Rejection of the proposed agreement linking the US, Canada and Mexico, it is warned, could be taken as a signal that protectionism and economic nationalism are the order of the day. If the notorious Smoot-Hawley tariff bill of 1930 is any precedent, this reasoning runs, last week's wobble on the markets could turn into a collapse.