Inflation Slows a Bit in July; August Spike Seen : Economy: Last month’s increase was still larger than expected, and that was before recent oil-price hikes. Stagflation is feared.

The pace of inflation slowed slightly during July, the government reported Thursday, but the improvement came before the recent rise in oil prices stemming from Iraq’s invasion of Kuwait. Analysts said prices may surge 1% or more in August.

The Labor Department’s monthly index of consumer prices rose 0.4% last month, the agency said, following increases of 0.5% in June and 0.2% in each of the two previous months. Housing and medical costs, which soared 0.9%, accounted for the bulk of the July increase.

Even so, the increase was larger than had been expected by economists and is considered likely to make it more difficult for the Federal Reserve Board to ease credit to help avert a recession. “This shows that we are already right about at the 5% (annual) inflation level--the point where policy-makers have to start worrying about inflation--and that is before you add in the oil shock,” noted Barry Bosworth, an economist at the Brookings Institution in Washington.

The figures came as, separately, the Commerce Department reported that housing starts nationwide plunged 2.6% in July, marking their sixth straight monthly decline--suggesting that the economy is continuing to weaken.

The combination of figures added to apprehension on Wall Street, where investors already were worried by reports that Iraqi President Saddam Hussein was predicting a protracted conflict in the Middle East.

The Dow Jones industrial index plunged 66.83 before finally closing at 2,681.44.

Ironically, Thursday’s report showed that energy prices declined in July, falling 0.7% from the previous month’s level.

A companion index that excludes volatile food, housing and energy costs--considered a more reliable measure of the underlying inflation rate--rose 0.5% in July, up sharply from the 0.2% hikes posted in May and June.

Separately, in the Los Angeles area consumer prices rose 0.4% in July, bringing prices in the Southern California region to 5.1% above their level a year ago.

Still, despite the relatively improved performance of the overall index in July, analysts predicted that the recent oil price increase will send the index surging in August, when higher gasoline prices skew figures for that month. They said that later increases should be smaller.

“The worst numbers will be for August,” said Frederick Breimyer, an economic forecaster and director of the New England Economic Project. “This hasn’t exactly been a gradual price change.”

For all of 1990, the consumer inflation rate is likely to hit 5.5%, if oil prices stay roughly where they are today, while prices are likely to rise at an annual rate of about 6% between now and next summer.

The higher inflation figures are starting to focus the attention of many economists on the potential for a return of the kind of stagflation that plagued the economy in the 1970s--a combination of slower growth and faster-rising prices.

“America’s worst economic fears could be coming true,” said Lawrence Hunter, deputy chief economist at the U.S. Chamber of Commerce.

That scenario would place the Fed in a terrible squeeze, similar to the one that plagued policy-makers in the 1970s and early 1980s.

Fed policy-makers then would have to choose between an economic slowdown brought on by tight monetary policies designed to curb inflation, or higher inflation brought on by easy money policies aimed at averting a recession.

“It is a time for choosing at the Fed,” Breimyer declared.

Most observers believe that the Fed will be forced--partly by public and political pressure, and partly by the economy itself--to ease credit and allow inflation to rise further so that the economy can grow.

Roger Brinner, an economist at DRI-McGraw Hill, a forecasting firm based in Lexington, Mass., argued that with the construction industry slumping and oil prices on the rise, the economy already has received two solid punches and doesn’t need a third from the Fed.

“We are about to experience a tremendous loss of purchasing power as a result of higher oil prices,” Brinner said. “Inflation has slowly crept up over the last three years and it will now take a period of very poor growth to counter it.”

Indeed, the housing figures released Thursday may force Fed policy-makers to think twice before moving too aggressively to curb inflation.

The Commerce Department said that housing starts fell to a seasonally adjusted rate of 1.15 million during July, the lowest for any month since September, 1982, when the economy was in a recession.

The 2.6% decline followed a 2.2% drop in June, and came despite July’s falling mortgage rates.

The July increase in consumer prices brought the overall index to a level 130.4% of its 1982-84 average. Thus, it took $13.04 to buy the same goods and services at retail last month that cost $10 in the early 1980s.

CONSUMER PRICE INDEX Percent change from prior month July, ‘90: +0.4% June, ‘90: +0.5% July, ‘89: +0.3% Source: Labor Department HOUSING STARTS July, ‘90: 1.15 June, ‘90: 1.18 July, ‘89: 1.42 Source: commerce Department Los Angeles Times