April 14 (Bloomberg) -- U.S. consumer prices rose 0.5 percent in March, a bigger than expected gain that may make the Federal Reserve more likely to raise interest rates this year. February's trade deficit narrowed as exports rose the most in seven years.

Higher energy and transportation costs contributed to the fourth straight increase in the consumer price index, the Labor Department said in Washington. Consumer prices excluding volatile food and energy rose 0.4 percent, the biggest increase in two years. The trade deficit narrowed to $42.1 billion from a record $42.5 billion, the Commerce Department said.

``There's no question this report increases the heat on the Fed to lift rates,'' Christopher Low, chief economist at FTN Financial in New York, said of the inflation figures.

San Francisco Fed Bank President Robert Parry told reporters that while the rise in prices wasn't ``comforting,'' the Fed won't become ``excessively concerned'' until there's a series of similar monthly increases.

``It's too early to say what signal is coming from those numbers,'' Parry said after a speech in Moraga, California.

The Fed has held its benchmark interest rate at an almost 46- year low since June to allow the economy to expand amid low inflation and weak job growth. Employment picked up with the addition of 308,000 jobs in March. Firms including Lehman Brothers Inc. moved up their predictions of how soon the Fed may raise rates, and investors pushed 10-year Treasury note yields to the highest this year.

``We're poised for higher interest rates, and we think that each economic statistic to come out will show an improvement in the economy,'' said James Hance, vice chairman of Bank of America Corp., in an interview.

The Treasury's 4 percent note maturing in February 2014 dropped 5/32 point, pushing the yield up 2 basis points to 4.37 percent at 5:32 p.m. in New York. Earlier the yield rose to more than 4.46 percent. The U.S. dollar gained the most against the yen since July 2002, climbing to 108.61 yen at 6:38 p.m. in New York from 106.58 yen yesterday.

Interest Rates

The Fed now may raise its overnight bank lending rate from 1 percent as soon as September instead of in next year's first quarter, Lehman Brothers economist Drew Matus said. Banc of America Securities LLC called August ``the latest likely date'' for an increase, and Bank One Corp. predicted boosts in September and December. The Fed has kept rates low in part to ward off more disinflation, or a slowing of inflation.

``Disinflation is clearly behind us, and rising core inflation is now well established,'' said Richard DeKaser, chief economist at National City Corp. in Cleveland.

The yield on the September Eurodollar futures contract rose 10 basis points to 1.635 percent, indicating traders expect a Fed interest rate increase as soon as the third quarter. The yield is up from 1.325 percent a month ago.

Mortgage Rates

Edward McKelvey, senior U.S. economist at Goldman, Sachs & Co. in New York, said the firm would want to see another month of similar data before changing its forecast that the Fed will wait until 2005 to raise rates. He raised his first-quarter growth forecast to 4.5 percent annual rate from 3.75 percent because of the trade data and yesterday's stronger-than-expected retail report.

Higher market interest rates have started to erode demand for home refinancing. The Mortgage Bankers Association's index of applications dropped 22.1 percent to 788.6 last week, the fourth straight decline, from 1012.9 the week before. The index of applications to refinance mortgages plunged 30.7 percent, and both declines were the biggest since the week ended July 25.

Economists had projected a 0.3 percent increase in the consumer price index, based on the median of 70 forecasts in a Bloomberg News survey. Core prices were forecast to rise 0.2 percent. Consumer prices were 1.7 percent higher in the 12 months ended in March, or 1.6 percent excluding food and energy, the Labor Department said.

OECD Projection

The trade gap had been forecast to narrow to $42.5 billion. Exports rose 4 percent, the most since October 1996, to $92.4 billion in February. Imports rose 1.6 percent to $134.5 billion.

``The fact that exports are rising is a sign that the global economy is in growth synch with the U.S.'' said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. ``Demand for our goods around the globe is on the rise again, and that is another important positive for the U.S. economy.''

The Organization for Economic Cooperation and Development today predicted the U.S. economy will expand 4.5 percent this year, the biggest advance since 1999, as lower taxes spur spending and investment and a weaker dollar bolsters exports.

Companies such as Kimberly-Clark Corp. and Procter & Gamble Co. are starting to pass along higher commodity costs, and rising prices may give executives more confidence to hire.

March's gain of 308,000 jobs was the most in almost four years. President George W. Bush, who won the tax cuts from Congress last year, is seeking re-election in November amid criticism from Democratic challenger John Kerry, a Massachusetts senator, about the loss of 1.8 million jobs in three years.

Fuel Costs

So far this year, consumer prices are rising at a 5.1 percent annual rate compared with a 5.4 percent pace at the same time last year. Core prices are increasing at a 2.9 percent annual rate, up from 1 percent in the first three months of 2003.

``What's striking about this report is that the bigger-than- expected rise resulted from a fairly broad range of price increases rather than one standout item,'' economist Low said. ``That in turn suggests inflation is showing up in more places than it has thus far in the recovery.''

Energy prices, which account for about a 14th of the index, jumped 1.9 percent in March as gasoline prices surged 5.5 percent. The cost of clothing gained 0.9 percent, the biggest increase since April 1999.

Food prices, which account for about a fifth of the index, rose 0.2 percent in March while the cost of medical care gained 0.6 percent. Housing costs, which include some energy costs and account for one-third of the index, climbed 0.3 percent. Hotel prices jumped 3.8 percent in March, the biggest increase since the Labor Department started tracking them in December 1997.

Companies

New auto prices fell 0.1 percent last month and are down 1 percent in the last 12 months.

Energy prices have been rising the past three months as the Organization of Petroleum Exporting Countries contemplated cutting production. Forecasts of increased energy consumption have also forced up costs.

Gasoline futures surged to the highest price in two decades of New York trading Monday after the International Energy Agency Friday increased its projection of global petroleum demand for the sixth straight month.

Increasing demand is helping companies lift prices and giving them more confidence to hire.

Cincinnati-based Procter & Gamble, the largest U.S. household-products maker, said Monday it will raise prices on Folgers coffee sold to restaurants, businesses and wholesale clubs by as much as 6 percent because of higher bean costs.

Dallas-based Kimberly-Clark said March 23 it would raise the prices of its Kleenex tissues and Scott towels an average of 6 percent to reflect higher costs for energy and fiber, a key ingredient in diapers and paper tissue.

Trade Gap

The trade gap in goods and services followed a revised $43.5 billion deficit in January, the Commerce Department said in Washington. Exports of automobiles, auto parts and industrial supplies climbed to the highest ever. The deficit with China narrowed to $8.3 billion from $11.5 billion in February as U.S. exports rose and imports dropped to the lowest in almost a year.

The dollar has lost 11 percent of its value in the last two years against a basket of currencies from the biggest trading partners. The decline has made U.S. products cheaper and contributed to improved sales abroad at companies such as Dell Inc. and Avon Products Inc. Stronger exports may help the trade gap narrow in coming months and spur American businesses to increase production.

``We expect to see a little of an improvement as the effects of a weaker dollar kick in,'' Parul Jain, deputy chief economist at Nomura Securities International Inc. in New York.

To contact the reporter on this story: Joe Richter in Washington at jrichter1@bloomberg.net

Last Updated: April 14, 2004 20:45 EDT