April 20 (Bloomberg) -- U.S. consumer prices jumped last month, suggesting Federal Reserve policy makers still have work to do to keep inflation from flaring. Costs excluding fuel and food showed the biggest increase in more than two years.

The consumer price index increased a larger-than-expected 0.6 percent in March after a 0.4 percent rise, the Labor Department said today in Washington. The gauge excluding energy and food rose 0.4 percent, twice the median forecast in a Bloomberg News survey and the biggest increase since August 2002.

Today's data, which followed a report yesterday showing tame core producer prices, suggest that airlines, hotels and clothing retailers are passing along higher costs of energy and other commodities. The acceleration of inflation pushed up yields on U.S. Treasury securities.

``It's clear that inflation risks have risen,'' said David Greenlaw, chief U.S. fixed income economist at Morgan Stanley in New York, who correctly forecast the rise in consumer prices. ``The Fed must weigh this against the recent signs of some moderation in economic activity.''

Futures traders today increased bets on the amount of Fed rate increases by yearend. The implied yield on the October federal funds futures contract rose to 3.5 percent from 3.45 percent. Central bankers are forecast to raise the overnight bank lending rate a quarter percentage point to 3 percent when they next meet on May 3 after seven such increases since June.

Inflation Risks

The Fed saw higher inflation risks at its last meeting on March 22 and debated whether to jettison language about sticking to a ``measured'' pace of rate increases. Fed officials said price risks were ``now tilted a little to the upside'' and the ``required amount of cumulative tightening may have increased.''

Central bankers ``had been hinting that their focus was shifting toward containing inflation and they have reason to be concerned,'' said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsylvania. ``I still don't think there is reason to expect a 50 basis-point move anytime soon. But with inflation the issue, look for more rate hikes for quite some time.''

The 4 percent note maturing in February 2015 fell 11/32, pushing the yield up 4 basis points to 4.26 percent at 12:30 p.m. in New York.

The spread between the yield on 10-year, inflation-adjusted Treasury notes and regular Treasury notes grew to 2.64 percentage points, the most since April 11, from 2.60 percent yesterday. That shows that expectations for inflation increased.

Investors will be watching for the Fed's release later today of its regional economic survey, known as the beige book, for indications of more corporate pricing power.

Average Earnings

Workers' real average weekly earnings fell 0.3 percent during the month, the second straight decline. Earnings also fell 0.3 percent in February.

Consumer prices rose 3.1 percent from March of last year, compared with a 3 percent year-over-year rise in February.

The consumer price index is the government's broadest measure of the costs of goods and services. Almost 60 percent of the index covers services.

At American Standard Cos., which makes Trane air conditioners and bath and kitchen products, higher retail prices haven't been enough to offset rising commodity costs, said Fred Poses, the Piscataway, New Jersey-based company's chief executive.

``Pricing may be a little more positive and materials less negative'' in coming months, Poses said on a conference call with investors yesterday.

Energy Prices

Yesterday, the government said U.S. wholesale prices rose 0.7 percent in March, also driven by higher energy costs. Excluding energy and food, prices paid to factories, farmers and other producers rose just 0.1 percent, the same as in February.

Energy prices, which account for about a 14th of the index, rose 4 percent in March after rising 2 percent the month before. Compared with a year earlier, energy prices were up 12.4 percent. Gasoline prices rose 7.9 percent in March, the most since October, and were up 17 percent from a year earlier.

It's not clear what effect rising oil prices will have on the economy, Richard Fisher, president of the Federal Reserve Bank of Dallas, said April 13 in a conference call.

Morgan Stanley economists last week lowered their predictions for first-quarter gross domestic product to 3.1 percent growth at an annual rate, a percentage point lower than they projected earlier this month. The revised estimates reflected reports from the Commerce Department that the trade deficit widened in February to a record and retail sales for March rose less than expected.

`Dilemma'

``With growth having slowed but core inflation moving up, the FOMC now faces something of a dilemma,'' said Joshua Shapiro, chief U.S. economist at MFR Inc. in New York. ``Too much tightening could cause growth to weaken by more than desired, while too little could allow core inflation to gain a foothold that might be tough to dislodge.''

Food prices, which make up about a fifth of the consumer price index, rose 0.2 percent last month, after a 0.1 percent increase in February.

The cost of all goods, including cars, apparel and food, rose 0.9 percent last month after rising 0.4 percent in February. Goods prices were 2.9 percent higher than last year.

Services increased 0.4 percent, after rising 0.3 percent in February, and were up 3.2 percent from a year earlier.

A 0.8 percent increase in clothing prices, the biggest in a year, and a 3.9 percent surge in the cost of staying at hotels, the largest increase since record keeping began in December 1997, were the biggest surprises in the report, economists said.

Clothing

Apparel prices were forecast to be tame following a flood of what were expected to be cheap Chinese imports in the first two months of the year. Those lower prices may take some time to filter through to consumers and may put downward pressure on clothing pricing in coming months, said Ian Morris, chief U.S. economist at HSBC Securities USA in New York.

Airfares rose 2.7 percent last month, the biggest increase since June 2001, after a 1.5 percent increase in February that was the biggest since July 2003.

Major U.S. airlines, including American Airlines, United Airlines and Delta Air Lines Inc., raised prices on leisure fares by $60 over a five-week period that ended April 1. The increases were part of plans to try to cover higher jet fuel costs.

Other businesses were still not successful in getting higher prices. Prices for new cars fell 0.4 percent in March. General Motors Corp., the world's largest automaker, yesterday reported a net loss of $1.1 billion in the first quarter and is trying to avoid a repeat in the current period. Part of Chief Executive Rick Wagoner's strategy is to cut vehicle prices.

Fuel

Gasoline prices have continued to rise. The average U.S. retail price for gasoline reached a record $2.32 a gallon for the week that ended April 11, according to the Energy Department.

Pepsi Bottling Group Inc. was able to pass along its higher costs for plastic resin, aluminum and sweeteners, Chief Executive John T. Cahill said April 12. The Somers, New York, company increased prices 4 percent in the fourth quarter, and those increases have stuck.

The company, the world's No. 2 soft-drink distributor, boosted its profit outlook for this year to at least $1.80 a share from its previous forecast of $1.78 a share.

``The U.S. pricing environment was favorable and the rate increases we implemented in the fourth quarter of 2004 have held in the marketplace,'' Cahill said in a statement.

To contact the reporter on this story: Courtney Schlisserman in Washington at cschlisserma@bloomberg.net

Last Updated: April 20, 2005 12:38 EDT