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CPI Leapt 0.6% In May

Consumer prices rose 0.6% in May, the biggest gain in more than three years, the Labor Department said Tuesday.

But a milder 0.2% rise in the core consumer price index, which excludes food and energy prices, eased investor fears that the Federal Reserve will have to swiftly raise interest rates. Core consumer prices rose a tame 1.7% from a year ago, down from April's 1.8% annual gain.

Treasuries rallied, with the 10-year yield diving 20 basis points to 4.68%, after closing at a two-year high of 4.88% Monday. The Nasdaq rose 1.3%, and the S&P 500 added 0.6%.

Other data out Tuesday showed that consumer confidence jumped this month, New York factories remained on a roll in June, and businesses restocked depleted inventories at a healthy pace in April. In short, the economy continues to charge ahead.

With the Fed's key lending rate still at a 46-year-low 1% even as job growth has taken off and inflation has crept higher, policy-makers have said they need to begin reducing monetary stimulus.

Fed Chairman Alan Greenspan reiterated Tuesday at a Senate Banking Committee hearing that rate hikes were "very likely" to occur at a "measured" pace.

"Our general view is that inflationary pressures are not likely to be a serious concern in the period ahead," Greenspan said.

Those words, along with the modest rise in core consumer prices, seemed to seal the deal for a 25-basis-point rate hike at the end of June instead of the half-point increase that investors had begun to fear.

But while markets breathed a sigh of relief, it would be premature to discount the threat of higher inflation, said Robert Gay, global head of fixed income research at Commerzbank Securities and a former Fed economist.

"This is not a good inflation report. I don't care how the market is trying to react," Gay said. "Even if you want to forget about food and energy prices, you're still up 1.3% in five months -- that's worse than last year as a whole," when core inflation was at 1.1%.

Over the past three months, core prices have climbed 3.3% at an annual rate, the most in nine years. Overall CPI has surged at a 5.5% pace, the most since late 1990.

With energy prices pulling back in June, after spiking 4.6% in May, markets paid less attention to the headline jump in the CPI, which was up 3% from a year ago.

Fed officials have expressed confidence that the recent resurgence of inflation will abate because of strong productivity growth and little pressure on employers to raise compensation.

But Gay thinks the Fed could be "unpleasantly surprised" over the next six to 12 months. "There's some momentum to this," he said. "By August they'll have discovered they have to pick up the pace" of rate hikes.

As core inflation was falling to a four-decade low last year amid global competition and overcapacity, firms couldn't raise prices and stretched their work forces to raise productivity, said Lakshman Achuthan, managing director at the Economic Cycle Research Institute.

Now "the resistance (to price increases) isn't as high as it used to be," he said. Global capacity is being soaked up amid strong growth in the U.S. and Asia, driving up commodities prices and import prices.

Services prices have continued to rise a little less than 3% a year. But now goods prices, which had been falling, were up 3% from a year ago in May, excluding foods and beverages.

"What some see as noise, we see as a cyclical upturn" in inflation, Achuthan said. "The longer the Fed stays out of the picture, the more likely this is to develop."