The Consumer Price Index, a survey of the prices of common goods used to gauge inflation, rose 5.6 percent over the past year with larger-than-expected jumps in the past three months. It rose 0.6 in May and 1.1 in June contributing to the biggest 12-month gain since 1991 during the first Gulf War.
The Federal Reserve, which has been concerned with stabilizing credit markets, has kept interest rates low to stave off a recession. With inflation fears growing, the Fed may consider raising interest rates. Low interest rates stimulate growth but can also contribute to inflation.
The Fed has maintained a key interest rate at 2 percent after aggressively cutting it from 5.25 percent beginning in September 2007.
U.S. markets were off in early morning trading after the news was released but later recovered.
Core inflation, which excludes energy and food, rose 0.3 last month, up from 0.2 in June. Increases in clothing costs and airline tickets contributed to the core inflation increase.
The Fed uses core CPI to gauge whether price increases extend beyond the volatile food and energy markets into the broader economy.
The steep increase in overall prices reflects a 4 percent jump in energy prices and a 0.9 percent jump in food costs. The price of gas, which hit a record average of $4.11 in mid-July, has fallen in recent weeks and could ease the pressure of energy costs and minimize inflation.
"If we don't get an unexpected shock that pushes commodity prices back up, this might be the worst inflation news that we'll get for a while," Gary Thayer, senior economist with Wachovia Securities in St. Louis, told Reuters.
In the labor market, another Labor Department report found that average weekly earnings fell by 3.1 percent in July compared to one year ago. Newly laid-off workers seeking unemployment benefits fell by 10,000 to 450,000 people, a drop that was less than anticipated. The four-week average for unemployment, a number that is a better indicator of labor trends, stands at 440,500, up from 421,000.