FINANCIAL MARKETS : Inflation Fears Drive Long Bonds Above 7% : Markets: Gold surges 2%. Traders view higher prices--or the cure, higher interest rates--as a potential drag on corporate profits.

Concern that inflation may be on the rise and lingering uneasiness about Federal Reserve policy caused the 30-year bond yield to soar past 7% Tuesday for the first time in nearly six weeks.

The weakness in bond prices and the lagging stock market led to a surge in gold prices.

Inflation concerns that nagged the market in the last week were further aggravated by the gold price rising more than 2%. Also, the Commodity Research Bureau’s daily price index, considered a reliable indicator of inflation, rose sharply.

The worries further fueled speculation that the Federal Reserve’s policy-making Federal Open Market Committee, meeting Tuesday in Washington, might begin leaning toward a policy of higher interest rates.

The proceedings of the Fed meeting won’t be made public for about six weeks.

By day’s end, the yield on the Treasury’s main 30-year bond had risen to 7.01% from 6.96% late Monday, sending its price, which moves in the opposite direction, down 5/8 point, or $6.25 per $1,000 in face value.

Trading was relatively light until the long bond’s yield broke the crucial 7% level in midafternoon. This prompted a rush to sell longer-term treasuries, which are hurt most by inflation.

“It was viewed as a pretty important technical break and brought more selling into the market,” said Dana Johnson, head of market analysis at First Chicago Capital Markets in Chicago.

The federal funds rate, the interest on overnight loans between banks, fell to 2.875% from 3.375% late Monday.

Commodities

Gold prices reached their highest point in more than two years as international tensions and failing confidence in stocks and bonds drove investors toward the shelter of the precious metal.

“What’s happening here is that gold is reacquiring its role as a flight-to-safety vehicle,” said William O’Neill, senior futures strategist with Merrill Lynch Futures.

Gold for current delivery jumped $8 an ounce, to $375.50 an ounce on New York’s Commodity Exchange, the highest settlement of a near-term contract since Jan. 29, 1991. The more actively traded June contract also rose $8 an ounce, to $376 an ounce.

Silver for current delivery soared 20.3 cents an ounce, to $4.606 an ounce.

The trickle of investor demand for precious metals that began in March has risen to a torrent as the Bosnia dilemma, currency instability, global economic weakness and fears of inflation in the United States have undermined confidence in other investments, analysts said.

“There is a lack of public confidence in general in governments in Europe,” said James Steel, metals analyst with Refco Inc. in New York. He said Tuesday’s vigorous rally began with buying by Swiss banks and other European interests.

In the United States, he said, “money funds are starting to flow out of the stock and bond markets, and a lot of it is starting to flow into precious metals.”

U.S. inflation fears, tickled by last week’s reports of rising producer and consumer prices, were raised another notch by the Commerce Department’s report Tuesday that housing starts were up 6.7% in April, after a slow first quarter.

Meanwhile, light, sweet crude oil for June delivery rose 17 cents a barrel, to $19.34 a barrel, on the New York Mercantile Exchange.

Other Markets

The concern about inflation and interest rates knocked the stock market lower as investors worried that either could eat into corporate profits and make stocks a less attractive investment.

The Dow Jones industrial average fell 5.54 points, to 3,444.39. In the broader market, declining issues outnumbered advancers about 4 to 3 on the New York Stock Exchange. Big Board trading came to 264.3 million shares, up from 227.58 million shares in the Monday session.

Early on, the market ignored good news about the economy.

The Commerce Department said construction of single-family houses and apartments jumped a better than expected 6.7% in April. Analysts had expected housing starts to advance about 6%.

But the focus Tuesday was on interest rates and inflation, said Hugh Johnson, chief investment officer at First Albany Corp.

“There is a gradual erosion of confidence,” Johnson said. “And confidence is crucial to the markets.”

Stock investors prefer low interest rates because cheaper borrowing by businesses tends to boost corporate profits, and the potential returns from stocks look more attractive next to interest-bearing investments.

Adding to the negative sentiment Tuesday was concern about President Clinton’s economic proposals, Johnson said.

* Many stocks sensitive to economic cycles, such as airlines, autos, steel and farm implements, tumbled. United Airlines fell 3/4 to 137 3/4; Bethlehem Steel dropped 1/8 to 20 1/8; Ford Motor tumbled 1 5/8 to 53 1/4; Caterpillar dropped 1 to 68.

* Gold stocks, which, along with the metal itself, are considered to offer a hedge against inflation, rose. American Barrick Resource rose 1 1/2 to 23 3/4; ASA jumped 2 3/8 to 50 1/2; Newmont Gold rose 2 3/4 to 44 7/8; Pegasus Gold, traded on the Amex, rose 2 to 23 7/8.

* Stocks tumbled abroad. In Tokyo, the 225-issue Nikkei stock average fell 336.12 points, or 1.63%, to close at 20,229.39. In London, the Financial Times 100-share average finished at 2,847.3, down 10.8. Frankfurt’s 30-share DAX average gained 0.60, to close at 1,628.48.

* In other actively traded NYSE issues, Royal Dutch Petroleum lost 5/8 to 89 7/8, mostly in dividend-related trading.

* Hewlett-Packard jumped 5 1/8 to 84 3/4 after posting stronger than expected second-quarter earnings. That buoyed other technology stocks. Compaq rose 2 1/8 to 55 3/8; IBM rose 1 3/8 to 49. Microsoft, traded on NASDAQ, rose 2 to 88 1/2.

* American Telephone & Telegraph rose 2 1/8 to 57 1/2, after it announced two new encryption products for data networks and cellular voice calls.

* Home Depot rose 1 3/4 to 44 1/4, after reporting solid first-quarter earnings.

* Dahlberg, the maker of hearing aids, fell 4 3/8, to 19 1/4, after the company said it was involved in a regulatory dispute with the Federal Trade Commission.

Meanwhile, the dollar rose against most major currencies, fortified by the higher U.S. interest rates and Danish voters’ approval of the European unity treaty.

In New York trading, the dollar closed at 1.624 German marks, up from 1.613 marks on Monday. The greenback rose to 111.445 Japanese yen, up from 111.30 yen.

The British pound fell to $1.5355 from less than $1.5360 late Monday.

Market Roundup, D4