By Lucia Mutikani
WASHINGTON (Reuters) - U.S. consumer prices rose only slightly in July as airline fares recorded their biggest drop since 1995, but tame inflation pressures will probably not discourage the Federal Reserve from raising interest rates this year.
A strengthening economy, marked by tightening labour market conditions and a firming housing sector that is driving up the cost of accommodation, should give the U.S. central bank confidence that inflation will gradually move towards its 2 percent target, economists said.
"Fed officials made clear that they do not need to see higher inflation before hiking. They just need to have reasonable confidence it will return to mandate," said Michelle Girard, chief economist at RBS (LONDON:RBS) in Stamford, Connecticut.
The Labour Department said on Wednesday its Consumer Price Index edged up 0.1 percent last month, also as gasoline and food prices increased marginally. July's rise in the CPI was a slowdown from the 0.3 percent gain in June but marked a sixth straight month of increase in the index.
In the 12 months through July, the CPI climbed 0.2 percent.
It was the second month the annual CPI increased after plunging crude oil prices pushed it into negative terrain in January.
Signs of an ebb in the disinflationary trend, combined with easing labour market slack and a pickup in economic growth are likely to be welcomed by policymakers.
At 5.3 percent, the unemployment rate is near the 5.0 percent to 5.2 percent range most Fed officials think is consistent with a steady but low level of inflation.
The economy grew at a 2.3 percent annual pace in the second quarter and appears to have sustained the momentum early in the third quarter.
GRADUAL RATE HIKES
Most economists have been expecting the Fed to raise its short-term interest rate next month for the first time in almost a decade.
Minutes of the Fed's July 28-29 meeting published on Wednesday showed the improving job market drew the central bank closer to a rate hike. But policymakers also expressed concern about weak inflation and tepid wage gains, which led markets to trim bets on a September liftoff.
Prices for U.S. Treasury debt prices rose on the Fed minutes, while the dollar extended losses against a basket of currencies. U.S. Wall Street pared losses, but concerns about the Chinese economy continued to weigh.
Any monetary tightening is likely to be gradual given the dampening effect on inflation of a strong dollar, renewed weakness in oil and other commodity prices, and China's devaluation of the yuan, which should push down import prices.
"The low inflation profile will certainly keep the Fed communicating a gradual glide path, but little in the July CPI report suggests that hikes should be delayed," said Gennadiy Goldberg, an economist at TD Securities in New York.
Goldberg noted that the six-month annualised pace of the CPI accelerated to 2.9 percent from 1.3 percent in June.
Although the so-called core CPI, which strips out food and energy costs, rose only 0.1 percent last month, that was largely because of the 5.6 percent decline in airline fares.
Economists expect the drop in air ticket prices, which was the largest since December 1995, will be temporary. Housing costs shot up 0.4 percent, the biggest increase since February 2007. That was on top of a 0.3 percent gain in June.
With the rental vacancy rate near a 22-year low, housing costs are likely to continue pushing higher, which should support underlying inflation.
"One key issue that is likely to emerge in the debate on inflation is the run-up in shelter costs. Rents are surging and in the face of stagnant wages that leaves less for consumers to spend elsewhere in the economy," said Diane Swonk, chief economist at Mesirow Financial in Chicago.
In the 12 months through July, the core CPI increased 1.8 percent. It was the fourth time in five months that the 12-month change was 1.8 percent.
Apparel prices increased after three straight months of declines. Prices for used cars and trucks and household furnishings and new motor vehicles fell last month.
