INFLATION FEARS; BIGGEST SURGE IN CPI SINCE OCTOBER 1990 : SPIKE IN CONSUMER PRICES FUELS INTEREST RATE CONCERNS.

Byline: Kimberly Blanton The Boston Globe

The government reported Friday that consumer prices rose at their fastest pace during the 1990s economic expansion, unnerving investors and heightening suspense over whether the Federal Reserve Board may raise interest rates to control inflation.

Investors responding to a 0.7 percent price increase in April hammered the bond market and drove the Dow Jones industrial index down 200 points before noon. The Dow never recovered, closing Friday at 10,913.32, off 193.87 points, or 1.75 percent.

``We're getting a very substantial inflation scare here,'' said Charles Clough, chief investment strategist for Merrill Lynch & Co.

Analysts do not expect the Fed to raise interest rates when board members meet on Tuesday. But, they argue, the CPI report greatly increased the odds the Fed would change its official stance on interest rates from ``neutral,'' to a tilt toward raising rates later this year.

``The next move from the Fed will be up,'' predicted Lawrence Horwitz, managing director of Primark Decision Economics in Boston.

A record spike in gasoline prices fueled inflation, as analysts had predicted. More worrisome, the Labor Department said the ``core'' inflation rate - minus energy and food prices - rose by a stronger-than-expected 0.4 percent. Higher prices for everything from prescription drugs and cigarettes to clothing helped propel the overall CPI higher.

The inflation report coincided with other news that the economy remains strong and inflation looms, including a hefty 0.6 percent rise in factory output last month and continued buoyancy in business confidence. On Thursday, the government reported producer prices shot up 0.5 percent in April.

Inflation is viewed as the single biggest threat not only to the economy but also to stability of a delicately balanced stock market. Before slumping Friday, stocks on Thursday broke through the latest of numerous record highs.

The stock market was led downward by financial companies, which are hurt by higher interest rates. Citigroup Inc., the nation's largest banking company, lost 2.4375 of its value, closing at 71 per share. The technology-heavy Nasdaq stock index declined 2.10 percent, and the Standard & Poor's 500 index fell 2.18 percent, compared with the Dow's 1.75 percent drop.

Investors are ``trying desperately to sustain these price-equity ratios but it gets more difficult as bond yields rise and inflation scares increase,'' said Clough at Merrill Lynch.

Fearing higher interest rates in the future, the bond market tanked, suffering its biggest rout in almost three years. The benchmark 30-year US Treasury bond fell 2 5/32 points. Yields surged 17 basis points to 5.92 percent, their highest in a year. Bond yields are up sharply from the beginning of the year.

``The ghost of inflation past is starting to haunt the bond and equity markets,'' said Ned Riley, chief investment officer for BankBoston Corp.

April's CPI had its biggest monthly advance since October 1990, marring a near-perfect inflation record during a sustained period of growth during the 1990s. For the 12 months including April, the CPI rose at a 2.3 percent annual rate.

The core inflation rate, at 0.4 percent, was markedly higher than the 0.1 percent rate in the first three months of 1999.

Various components that go into the CPI rose sharply. The largest single factor was energy costs, which rose 6.1 percent in April. Gasoline prices, which rose 15 percent, had the biggest monthly increase on record - bigger even than increases posted during the 1970s embargo by Middle East oil producers.

Apparel prices rose for the first time since August - up 1.5 percent in April. Transportation costs, fueled by higher gasoline prices, rose 2.4 percent. Medical costs, under pressure from prescription drugs, rose 0.4 percent in April and are up 3.5 percent for the year.

CAPTION(S):

2 Photos, 2 Charts

PHOTO (1--Color) Traders watch prices tumble in the 30-year Treasury Bond pit Friday at the Chicago Board of Trade. Inflation fears triggered the drop.

Charles Bennett/Associated Press

(2--Color) Alex Lopez fills up on Friday in Chicago. Gas prices have jumped.

Michael S. Green/Associated Press

CHART: (1) CONSUMER PRICES UP

Percent change, month to month, seasonally adjusted.

SOURCE: Bureau of Labor Statistics 

(2) TRACKING THE DOW

Thursday's close: 11,107.19

Friday's close: 10,913.32 (- 193.87)

Associated Press