U.S. producer inflation came in stronger than expected in February thanks to the rapidly rising price of oil.

The U.S. PPI rose by a greater-than-expected 1.0% in February, following a 1.6% spike in the prior month. “Oil is obviously the driving force, as the core PPI was in fact far below expectations, dropping 0.5% last month after a 0.9% jump in January,” notes BMO Nesbitt Burns. “The drop in core PPI is clearly a reversal of the fluky rise in January — over the past year, core PPI is now up a mere 0.1%, which is a more accurate picture of the underlying story in PPI inflation.”

Nesbitt notes however that, while the underlying inflation story remains quite benign at the finished goods level, there are still clear signs that some pressure is building at the earlier stages of production.

RBC agrees, noting that intermediate materials excluding food and energy increased by 0.7%, and crude materials excluding energy increased by 2.7%. “Hence, this morning’s update signals that while energy prices played a significant role, there is also evidence of a broadening out in price pressures. It is still early, but if Iraq proves to be just a near term headache for markets and price pressures continue to broaden out, then that points to a rapid removal of excess monetary stimulus late this year and throughout 2004,” says RBC. “In the near term, large capacity excesses and downside risks to growth will keep such price gains excluding energy influences at a relatively modest pace.”

“The latest evidence of deflation in core producer prices should provide further downward pressure on the CPI, and does little to stand in the way of a further 50 basis points of easing by the Fed before the first half of 2003 is out,” offers CIBC World Markets.

“After a brief scare in January, today’s results reinforce the point that U.S. inflation remains a one-trick pony — oil prices. The underlying trend in core inflation is flat,” Nesbitt concludes. “However, pressure is stirring at the early stages of production, so fears of deflation seem overblown.”