WASHINGTON (Reuters) - U.S. consumer prices recorded their biggest drop in eight months in September as the cost of gasoline fell, but a steady pick-up in the prices of other goods and services suggested inflation was poised to rise.
There was good news on the labor market, with other data on Thursday showing new applications for unemployment aid fell back to a 42-year low last week. The very low level of layoffs and gradually firming underlying inflation could keep the door open to an interest rate increase from the Federal Reserve this year.
"Today's reports strengthen our view that the U.S. economy remains on the right track and should help to bolster the Fed's confidence that it is getting ever closer to meeting both of its mandates. We expect the first rate hike in December," said Harm Bandholz, chief economist at UniCredit Research in New York.
The Labor Department said its Consumer Price Index fell 0.2 percent last month after slipping 0.1 percent in August. In the 12 months through September, the CPI was unchanged for the first time in four months. It rose 0.2 percent in August.
Stripping out food and energy costs, prices rose last month. The so-called core CPI gained 0.2 percent after ticking up 0.1 percent in August. In the 12 months through September, the core CPI increased 1.9 percent, the largest gain since July 2014, after advancing 1.8 percent in August.
The Fed tracks the personal consumption expenditures price index, excluding food and energy, which is lower than the core CPI. Low inflation, which has persistently run below the U.S. central bank's 2 percent target, is a major hurdle to an interest rate hike this year.
Stocks on Wall Street rose on the data, snapping a two-day losing streak. Prices for U.S. government debt fell, while the dollar rose against a basket of currencies.
Top Fed officials are divided on whether to tighten monetary policy, with governors Lael Brainard and Daniel Tarullo this week urging against raising interest rates. In contrast, Fed Chair Janet Yellen and Vice Chair Stanley Fischer have recently said they support raising rates this year.
Expectations of a lift-off in the U.S. central bank's short-term interest rate have been dealt a blow by an abrupt slowdown in job growth in the last two months and softening economic activity because of a strong dollar, lower oil prices and a weakening global economy.
The stumble in job growth, however, is at odds with the very low levels of layoffs. In a second report, the Labor Department said initial claims for state unemployment benefits fell 7,000 to a seasonally adjusted 255,000 for the week ended Oct. 10.
Claims were last at this level in July, which was the lowest since November 1973. Nonfarm payrolls growth in August and September averaged 139,000, the weakest two-month rise since January last year.
The slowdown is puzzling given job openings are at record highs. Some economists say the step-down in hiring is because employers cannot find qualified workers for the open jobs.
"Claims continue to show no sign of an uptrend, reinforcing our view that the sudden slowing in payrolls in the last two months mainly reflects volatility rather than a fundamental change in the trend," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics in Valhalla, New York.
The four-week moving average of claims, considered a better measure of labor market trends as it irons out week-to-week volatility, fell to the lowest level since December 1973.
The inflation report showed gasoline prices fell 9.0 percent, the biggest drop since January, after declining 4.1 percent in August.
Food prices increased 0.4 percent, the largest increase since May 2014, and rents increased 0.4 percent. Expensive food and accommodation could hurt consumer spending, even with cheaper gasoline.
The cost of medical care, household furnishings and personal care products increased last month. However, apparel prices fell as did the cost of new vehicles and used cars and trucks. Airline fares also declined.
While the inflation and jobless claims data allayed some of the concerns about the economy, manufacturing remains a weak spot. Separate reports showed factory activity in New York state and the mid-Atlantic region contracted further in October.
"We did not anticipate manufacturing to be a driver of growth in 2015, given the strengthening in the dollar, and turmoil in emerging markets may be adding to weakness," said John Ryding, chief economist at RDQ Economics in New York.
Reporting by Lucia Mutikani; Editing by Andrea Ricci