By Burton Frierson
NEW YORK (Reuters UK) - Weak retail sales and a rise in producer prices at their highest annual rate in 27 years provided further evidence of "stagflation" in the U.S. economy on Tuesday.
Federal Reserve Chairman Ben Bernanke reinforced the troubled outlook for the world's largest economy, saying growth faced significant downside risks, even though the Fed raised its forecast for economic growth as well as for inflation.
In its semi-annual monetary policy report to Congress, the Fed raised its projection for growth in 2008, but this provided cold comfort to investors hit by the downturn in the stockmarket and to consumers facing soaring energy prices and higher unemployment.
Economists attributed the Fed's rosier growth outlook to government economic stimulus checks, which many consumers have already spent.
The U.S. Labor Department said producer prices over the last 12 months jumped 9.2 percent, the biggest increase since a 10.4 percent gain in June 1981 when the United States was last mired in a stagflationary period of low growth and high inflation.
"The PPI number is just outrageous," said T.J. Marta, fixed-income strategist at RBC Capital Markets in New York.
On Wall Street, U.S. stocks initially fell after Bernanke's comments but later recovered on optimism over a fall in oil prices on Tuesday.
The U.S. dollar was also weaker after seeing a new record low against the euro overnight. U.S. government bonds <US10YT=RR>, which generally benefit in times of economic weakness, saw their yields fall as investors pared their bets on the possibility of Fed interest rate rises this year.
CONCERN OVER ECONOMY
Total sales at U.S. retailers rose a less-than-expected 0.1 percent in June, as auto sales posted their biggest drop in more than two years, a Commerce Department report showed.
Also on Tuesday, General Motors (GM) said it would cut employment costs, sell assets and borrow at least $2 billion (1 billion pounds) to bolster its finances in the face of plummeting sales.
In remarks to the Senate Banking Committee, Bernanke focused on stress in financial markets.
He also said the possibility of higher energy prices, tighter credit conditions, and a deeper contraction in housing markets represented "significant downside risks" to the growth outlook.
Worryingly, he also said the risks of higher inflation had intensified on the back of the rising prices of energy and other commodities, but analysts zeroed in on the weak growth prospects.
"There seems to be more emphasis on the concerns for the economy rather than on inflation," said Kevin Flanagan, fixed income strategist for global wealth management with Morgan Stanley in Purchase, New York.
"These are all signs the Fed has no room to raise rates anytime over the near term.
However, the Fed raised its projection for growth in 2008 to a range of 1.0 percent to 1.6 percent from a 0.3 percent to 1.2 percent range it forecast in April on expectations for stronger consumer spending.
President George W. Bush said the economy was expanding but "not growing the way it should."
"I'm not an economist, but I do believe that we're growing," Bush said at a news conference.
A regional manufacturing survey showed factory activity in New York contracted for the fifth time in six months and data in the report suggested producers were passing on higher prices to consumers, which could add further fuel to inflation.
CHECKS ALREADY CASHED
Economists had expected government tax rebate checks to boost June retail sales more, despite the weak economy, but much of that seems to have been reflected in May's gains.
Economists polled by Reuters had forecast total retail sales to rise 0.4 percent in June after a 0.8 percent gain in May that was initially reported as a 1.0 percent rise.
Excluding autos, retail sales rose 0.8, which was also below the pre-report consensus of 1.0 percent. Excluding autos, building supplies and gasoline, retail sales rose 0.4 percent.
U.S. producer prices rose a far larger-than-expected 1.8 percent on the month in June as energy costs soared. If there was any good news on inflation, it was that core prices at the producer level, which exclude food and energy, edged up just 0.2 percent.
(Additional reporting by Pedro Nicolaci da Costa in Washington and John Parry in New York)
