Soaring gasoline prices helped drive up U.S. consumer prices in May at the fastest rate in six months, the government said, but core prices remained tame, easing inflation fears in financial markets.
A separate report showed U.S. consumer sentiment tumblingto a 28-year low in June, with some lessening of expectations on inflation one year out and a steady reading on long-term inflation expectations, which held at a 13-year high.
The Commerce Department said the Consumer Price Index rose a steep 0.6 percent in May, a touch more than Wall Street had expected, after a modest 0.2 percent gain in April.
However, so-called core prices, which exclude volatile food and energy cost, edged up just 0.2 percent. (Video: CNBC's Steve Liesman looks behind the CPI numbers).
Surging gasoline prices and soft labor market conditions have depressed consumer spirits. The Reuters/University of Michigan sentiment index for this month dropped to 56.7 from 59.8 in May. Wall Street economists had expected a decline to only 59.5.
"Today's inflation numbers do not put any additional pressure on the Fed to hike interest rates," said Mark Vitner, senior economist at Wachovia Corp.
"The Fed is not nearly as behind the curve as some people currently believe." U.S. bond prices rose and the dollar slipped as traders scaled back expectations of Federal Reserve interest rate hikes.
The stock market welcomed the news on core inflation, with all the major averages higher.
The reassuring data followed a series of inflation warnings from central bankers around the globe, and capped off a week in which expectations of higher U.S. rates had climbed sharply.
Energy prices surged 4.4 percent in May, the biggest rise since November, after holding steady in April. Gasoline prices spiked 5.7 percent, also the biggest rise in six months. The cost of food rose 0.3 percent after climbing 0.9 percent in April.
Over the past year, consumer prices have risen 4.2 percent on soaring food and energy costs, the highest reading since January. But core prices are up a tamer 2.3 percent over the past 12 months, the same as in April.
Officials at the Fed and other central banks have made clear they are on high alert for signs the sharp run-up in food and gasoline prices is bleeding through to other costs, and they will likely welcome the benign reading on core prices.
The central bank focuses on core inflation in setting interest rates because it believes the sharp price swings food and energy often exhibit can obscure underlying inflation trends.
However, in recent days, Fed officials have cast a wary eye on record-high oil prices and warned about the risk that rising inflation expectations could become self-fulfilling.
"The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations," Fed chief Ben Bernanke said Monday. He added that the Fed would "strongly resist an erosion of longer-term inflation expectations."
The Reuters/University of Michigan's gauge of one-year inflation expectations edged down to 5.1 percent from May's 5.2 percent, just off the highest in 26 years.
However, a reading on five-year inflation expectations held steady at May's peak of 3.4 percent, which was the highest since April 1995.
Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut, said the steady reading on the five-year figure comforted markets.
"The fear was that this would rise further and fuel the burgeoning expectations of rate hikes," he said.
Interest rate futures prices showed expectations of a quarter-percentage point rate increase in August fell to about 70 percent. Previously they had been fully priced in.
The central bank lowered benchmark borrowing costs at its most recent meeting by a quarter-percentage point, to 2 percent, the seventh reduction in a series dating to mid-September that has taken rates down by a cumulative 3.25 percentage points.
The Fed is expected to hold rates steady at its upcoming meeting on June 24-25, but markets are bracing for a series of rate hikes later in the year.