Despite declining energy costs, wholesale prices soared in July, giving the economy the worst 12 months of inflation in almost three decades and increasing pressure on the Federal Reserve to raise interest rates.

The producer price index rose 1.2% in July alone, about double the increase expected by economists, the Labor Department said Tuesday. Excluding food and fuel, the index surged 0.7%, also more than expected.

The overall index last month was up 9.8% from a year earlier, the sharpest rise since 1980-81.

Some analysts say inflation will moderate as lower fuel costs work their way through the economy, but Tuesday’s report still generated concern.


“The risks are as elevated as they’ve been on inflation since the 1980s,” said Vincent Reinhart, a former Fed official.

Meantime, the Commerce Department reported that the annual rate of housing starts in July was down 11% from June, suggesting the worst isn’t over in that vital sector.

The economic news, coupled with persistent concerns about financial companies, drove the Dow Jones industrial average down 130 points.

Normally, the Fed would seek to choke off inflation by raising interest rates. But with the housing and financial sectors still struggling, a rate boost could deepen and lengthen the current downturn.


“This is a terrible time to be a central banker,” said Reinhart, a scholar at the American Enterprise Institute in Washington. “The Federal Reserve is caught in the economic cross-fire. They’re pinned down and they can’t do anything.”

But other economists suggested the pressure on the Fed to cut rates would ease as the lower costs of energy and other commodities are felt. Oil futures, which closed at a record $145.29 on July 3, finished Tuesday at $114.53.

“With energy and other commodity prices currently on the wane, the July spike in core producer prices is quite likely to be the worst we will see in the near term,” said Ken Beauchemin at forecasting firm Global Insight in Lexington, Mass.

Asha Bangalore, an economist at Northern Trust Co. in Chicago, noted that consumer inflation had remained more moderate than wholesale inflation because many businesses were absorbing some of their higher costs instead of passing them on to customers.


Inflation typically gets out of control when consumers and businesses start building higher prices into their long-term economic planning. But the Fed is betting that consumers have not yet begun to act as if high levels of inflation are here to stay, Reinhart said.

“So far inflation expectations remain anchored, but that’s a risk,” he said.

The trade-off between fighting inflation and fostering economic growth has been a subject of debate at the Fed for months. Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, Va., said Tuesday he didn’t want to wait too long to combat inflation by raising interest rates.

“It is important to withdraw this monetary policy stimulus in a timely way,” Lacker told Bloomberg News. “That may require us to withdraw before we are certain all of the weakness is behind us and before we are completely certain that financial markets are as tranquil as we would like to see.”


But that view appears to be a minority opinion at the Fed, at least for now. For Federal Reserve Chairman Ben S. Bernanke, waiting too long to rein in inflation would be less costly than deepening the recession, said Joel Naroff of Naroff Economic Advisors in Holland, Pa.

“He would rather make the mistake of keeping rates low too long,” Naroff said, “rather than raising them too soon.”

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maura.reynolds@latimes.com