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Fire and ice of high inflation, low growth

NEW YORK - The global economy is teetering between ‘the ice of recession and the fire of inflation’ as policy-makers struggle to battle rising prices without choking off growth, data and comments from officials around the world showed on Friday.

U.S. economic figures showed sentiment among consumers remained near 28-year lows this month, with the vast majority convinced that the country is in a recession that is only getting worse. They also expect inflation to rise further.

Japanese consumer sentiment hit a record low not seen in the 26 years of the government's confidence survey. Consumers worldwide have been battered by the surging price of oil, which hit yet another record high on Friday.

The world economy is teetering "between the ice of recession and the fire of inflation," International Monetary Fund Managing Director Dominique Strauss-Kahn said in Yalta, Ukraine, where he was attending a conference.

Making matters worse, the U.S. economy is struggling with a year-old financial crisis that is deepening by the day, with alarm swelling that mortgage financing giants Fannie Mae and Freddie Mac might run short of capital.

Economists worry that the crisis may ultimately exacerbate burgeoning inflation in the world's largest economy by undermining confidence in the dollar.

"What is at stake here? The dollar," said Michael Cheah, a vice president and portfolio manager at AIG SunAmerica Asset Management, in Jersey City, New Jersey.

"If the government were to step up and in any way solidify the guarantee, this means that we would double our federal debt," Cheah said. "This means that the next administration would no longer have something called fiscal policy."

Pressure, but no bailing

Pressure mounted for the U.S. government to act more swiftly to prevent the housing crisis from dragging down the nation's top mortgage finance agencies, but Treasury Secretary Henry Paulson indicated that a bailout was unlikely.

The U.S. Federal Reserve said it had not discussed access to its emergency discount window borrowing facility with Fannie Mae and Freddie Mac, though some analysts said such a move might be a short-term solution.

Major credit rating agencies said they saw no risk to the United States' "AAA" sovereign credit rating from any government takeover of the mortgage behemoths, but bond market dislocations told a different story.

U.S. and European stocks fell sharply on the day. Shares in Tokyo also lost ground. The dollar fell across the board. U.S., euro zone and Japanese government bonds all fell.

Bonds would normally be favored in times of financial uncertainty, but the worries over what a bailout of Fannie Mae and Freddie Mac could mean for U.S. Treasuries spread throughout global debt markets.

Weak growth and high inflation leave central banks such as the U.S. Federal Reserve in a bind. The Fed, which has bet the soft economy would eventually tame prices, may have to decide whether to keep interest rates low to support growth or raise them to damp price increases.

Stagflationary?

In the United States, the Reuters/University of Michigan Surveys of Consumers said the preliminary July reading for its index of consumer sentiment rose slightly to 56.6 from June's final result of 56.4.

The rise was not seen as a robust economic sign given that the June reading was the lowest since 51.7 in May 1980, which was also the weakest reading ever.

The Surveys of Consumers also said one-year inflation expectations jumped to the highest since the stagflationary year of 1981, rising to 5.3 percent from June's 5.1 percent. A stagflationary economy packs the double woe of falling growth and rising inflation.

Consumer confidence has also slumped in Japan, where a government survey on Friday showed it hitting its lowest since the survey began in 1982.

Germans are more gloomy about their own economic outlook than at any time since reunification in 1990 because of rising prices, a poll showed.

German June wholesale prices rose 8.9 percent year-on-year, the largest since a 9.5 percent rise in West German wholesale prices in January 1982.

Adding to the gloom, the price of oil jumped to a record high above $147 a barrel before settling back a bit. The surging price of crude has been a key factor in the acceleration of inflation around the world.

Data showed U.S. import prices climbed 2.6 percent in June on a surge in petroleum imports that led to gains in a broad range of sectors, adding more evidence of inflation worries.

In Spain, inflation hit a 13-year high in June and analysts saw it rising further this summer, deepening a severe economic slowdown there and pressuring consumer prices in the wider euro zone.

The U.S. trade deficit shrank unexpectedly in May, helping to shore up the weak U.S. economy a bit, even though average prices for imported oil surged during the month to a record $106.28 per barrel, government data showed.