(NEW YORK) US inflation accelerated in June to its fastest rate since the aftermath of Hurricane Katrina in 2005 while workers' earnings slumped, compounding the difficulties for policy-makers trying to support a weak economy without fuelling price pressures.

Industrial output unexpectedly rose 0.5 per cent in June, confounding expectations of no rise at all and following a fall in May, which might allay some concerns about a weak economy.

However, the Consumer Price Index, the government's key measure of inflation, advanced 1.1 per cent during the month, the biggest monthly rise since September 2005, when Hurricane Katrina caused a spike in energy prices.

Excluding volatile food and energy prices, the so-called core CPI rose by a more tame 0.3 per cent, but that rise was still higher than the 0.2 per cent gain expected.

Compared with a year ago prices were up 5 per cent, the biggest year-on-year rise since 1991. Coupled with data in the same report showing real weekly earnings fell 0.9 per cent in June, it heightens fears the US economy could be entering a stagflationary period of low growth and high inflation.

'The report underscores the stagflationary environment we are in right now, which is not good for the dollar,' said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto. 'There is so much uncertainty in the market right now that news of higher inflation doesn't mean a rise in interest rates.'

Economists said the big rise in consumer prices makes the Fed's task of shoring up economic growth and curbing inflation more difficult.

'This increases concern that the Fed is not going to be able to lower interest rates if the economy remains weak. And as long as the economy remains weak, it will be hard for the Fed to raise rates to fight inflation,' said Gary Thayer, chief economist at Wachovia Securities in St Louis.

He noted the core inflation rate is now 2.4 per cent for the year ended in June, which shows that some of the increases in commodity prices are spreading to the prices of other goods.

The data came as Fed chairman Ben Bernanke began the second day of congressional testimony before a House of Representatives panel.

Officials at the US central bank have said they are keeping a close eye on inflation expectations.

The 5 per cent annual inflation rate in yesterday's data is very close to the 5.3 per cent one-year inflation expectation in this month's Reuters/University of Michigan consumer sentiment report. However, Fed officials stress long-term expectations, which are currently running at 3.4 per cent.

On Wall Street, stock futures opened flat after the CPI report. The US dollar initially rallied then snapped back, while government bonds, which suffer during periods of inflation, fell.

US mortgage applications rose for a third consecutive week, reflecting an increase in demand for home loan refinancing as interest rates plunged, an industry group said.

The report by the Mortgage Bankers Association provided a rare glimmer of hope for the housing sector, which is the origin of the economy's current malaise and source of turmoil in financial markets.

On a slightly brighter note, crude oil futures fell more than US$5 a barrel in New York after a US Energy Department report showed an unexpected increase in inventories.

Supplies rose 2.95 million barrels to 296.9 million barrels last week, the report showed. Inventories were forecast to drop 2.2 million barrels, according to the median of analyst estimates in a Bloomberg News survey. Prices tumbled 4.4 per cent yesterday on signs that the slowing US economy is cutting fuel use. -- Reuters, Bloomberg