The Labor Department said its Producer Price Index rose by 1.2 percent in July, more than double the expected rate, and lifting the current annual rate to the loftiest level in 27 years. Even after stripping out food and energy, core prices rose by a higher-than-expected 0.7 percent, the biggest increase since November 2006.
A midday rebound in oil prices added to investors' anxiety.
"Maybe investors were hoping to shrug off the challenges of high commodity prices and inflation," said Jack A. Ablin, chief investment officer at Harris Private Bank. "But now we find out that perhaps the inflation situation is worse than we thought."
The resurgence of inflation as a prime concern for investors arrives amid grim readings on the housing market and the banking sector. The Commerce Department said July housing starts fell to an annual rate of 965,000 units -- higher than analysts predicted, but the lowest level in more than 17 years nonetheless.
Lehman Brothers Holdings Inc., meanwhile, came under pressure Tuesday after a JPMorgan Chase & Co. analyst estimated the investment bank will have to write down its investments during the third quarter by $4 billion. With the nation's banks low on available cash due to its poor investments in the mortgage markets, consumers and businesses are having a harder time getting loans -- another hindrance for the economy.
In midday trading, the Dow Jones industrial average fell 152.34, or 1.33 percent, to 11,327.05, after losing 180 points on Monday.
Broader stock indicators also extended their declines. The Standard & Poor's 500 index fell 14.44, or 1.13 percent, to 1,264.16, and the Nasdaq composite index fell 32.66, or 1.35 percent, to 2,384.32.
Bond prices slipped. While investors often seek the shelter of government debt when bad news arrives, inflation is unwelcome for bonds because it devalues their fixed returns. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.83 percent from 3.82 percent late Monday.
The dollar fell against other major currencies, driving up oil. Gold prices also turned higher.
Over the past few weeks, one of the few bright spots for Wall Street has been the tumbling price of oil. But after falling from its July record above $147 a barrel to three-month lows, crude rebounded Tuesday by $2.83 to $115.70 a barrel on the New York Mercantile Exchange.
Lehman fell $1.55, or 10.3 percent, to $13.48. There have been reports swirling that the investment bank might have to sell one of its businesses to raise cash.
Retailers reported mixed quarterly results, adding to investors' uncertainty about the economy.
Home Depot Inc. reported a 24 percent decline in its second-quarter earnings but topped Wall Street's expectations. The nation's largest home improvement retailer reiterated its forecast for the year. Shares dipped 57 cents, or 2.1 percent, to $26.39.
Target Corp. said its second-quarter earnings fell 7.5 percent, but it beat forecasts despite anemic sales. Shares fell 45 cents to $49.60.
And Saks Inc. reported a wider-than-expected loss in the second quarter as its affluent shoppers cut back on apparel. The luxury goods retailer also issued a downbeat forecast for the year. Shares dropped $1.31, or 11.7 percent, to $9.91.
The Russell 2000 index of smaller companies fell 11.40, or 1.54 percent, to 730.57.
Declining issues outnumbered advancers by about 3 to 1 on the New York Stock Exchange, where volume came to 417.25 million shares.
Overseas, Japan's Nikkei stock average fell 2.28 percent. In afternoon trading, Britain's FTSE 100 fell 2.10 percent, Germany's DAX index lost 2.08 percent, and France's CAC-40 fell 2.27 percent.
On the Net: New York Stock Exchange: http://www.nyse.com
Nasdaq Stock Market: http://www.nasdaq.com
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