Market confidence was further undermined by remarks by Helmut Kohl, the German Chancellor, at a conference in Berlin. He said he saw no reason to sound the all-clear on German inflation.
The US producer price index rose 0.6 per cent in August. This was the biggest one-month increase since October 1990, taking the year-on-year rate of increase to 2.9 per cent. Coffee prices jumped 12 per cent during the month, beef prices 6.9 per cent and petrol 6.8 per cent.
More worryingly, the increase in 'core' prices, which exclude food and energy, was 0.4 per cent in August, and 1.9 per cent over 12 months. A Labor Department official said the increases had been widespread across different categories of goods.
The rise was bigger than expected, as the core index had been virtually flat in previous months. However, rising commodity prices and shrinking spare capacity in US factories have begun to affect factory gate prices. The index had climbed 0.5 per cent in July.
Traders had been poised to react to the figures because surveys published in the intervening month had suggested inflation was beginning to build up steam. Last week's National Association of Purchasing Managers survey had reported price pressures in each of the 20 industries it covered.
Tony Vignola, chief economist of the New York broker Kidder Peabody, said: 'Every indicator of inflation is now signalling a deterioration. The markets have not over-reacted.'
Financial markets are waiting to see whether the inflationary pressure will show up in August's consumer prices, to be published on Tuesday. If they jump, analysts expect the Federal Reserve to consider another increase in interest rates to slow down growth.
Chris Iggo, US economist at Chase Manhattan Bank, said: 'The Fed said last month it thought it had done enough, but the markets will not recover if it fails to react to further bad news.'
Stuart Parkinson, international economist at Morgan Grenfell, said: 'It is not clear that the economy has slowed down enough to prevent inflation. If it has not, I think the Fed will act early, as it has before.'
Separate figures published yesterday showed the volume of retail sales in Germany fell 6 per cent in the 12 months to July. This suggested consumer spending weaker than economists had expected. Yet the official comment on inflationary dangers overrode this evidence.
Speaking at the same conference as Chancellor Kohl, the Bundesbank president, Hans Tietmeyer, said growth of M3, the broad money measure on which the German central bank puts the highest priority, had flattened but was still too fast.
The comments put paid to speculation earlier this week that the Bundesbank might be prepared to cut German rates again.
The US bond market dived on publication of the US figures, the yield on benchmark government bonds rising from 7.57 to 7.71 by the close. The Dow Jones index ended 33.65 points lower at 3,874.81, while the dollar fell against the German and Japanese currencies. It closed down nearly 2 pfennigs at DM1.537 in London.
Other markets were dragged down by heavy selling after the US fall. In London the gilts market closed sharply lower, and the FT- SE 100 index fell 40.7 points to 3139.3. Other European markets, including Germany, France and Switerland, closed lower.Reuse content