WRAPUP 1-U.S. labor costs accelerate in third quarter as wages rise

* Employment cost index rises 0.7 percent in third quarter

* Wages increase 0.7 percent, benefits up 0.8 percent

WASHINGTON, Oct 31 (Reuters) - U.S. labor costs accelerated in the third quarter, leading to the biggest year-on-year increase in 2-1/2 years and offering hope that wage growth was finally gaining momentum amid a tightening labor market.

The Employment Cost Index, the broadest measure of labor costs, increased 0.7 percent amid gains in wages and benefits after an unrevised 0.5 percent rise in the second quarter, the Labor Department said on Tuesday.

That lifted the year-on-year rate of increase to 2.5 percent, the largest gain since the first quarter of 2015.

The dollar rose to a session high against a basket of currencies on the data. The third-quarter increase in the ECI was in line with economists' expectations.

Wage growth has remained stubbornly modest even as the labor market is near full employment, with the jobless rate at a 16-1/2-year low of 4.2 percent.

Economists say labor costs need to rise by at least 3 percent to push inflation closer to the U.S. central bank's 2 percent inflation target. Labor costs increased 2.4 percent in the year to June.

Signs of a pickup in wage growth are likely to be welcomed by Federal Reserve officials, who are scheduled to begin a two-day policy meeting later on Tuesday. The U.S. central bank is unlikely to raise interest rates this week, but is expected to do so in December. It has raised rates twice this year.

Steadily increasing wages offer hope that inflation could soon trend higher.

A government report on Monday showed the Fed's preferred inflation measure, the personal consumption expenditures (PCE) price index excluding food and energy, increasing 1.3 percent in the 12 months through September. The core PCE has undershot the Fed's 2 percent target for nearly 5-1/2 years.

The ECI is widely viewed by policymakers and economists as one of the better measures of labor market slack. It is also considered a better predictor of core inflation.

Wages and salaries, which account for 70 percent of employment costs, rose 0.7 percent in the third quarter. They increased 0.5 percent in the second quarter. Wages and salaries were up 2.5 percent in the 12 months through September. That followed a 2.3 percent gain in the year to June.

Private industry wages rose 0.7 percent in the third quarter. They increased 2.6 percent in the 12 months through September. Wages in the manufacturing sector rose 0.8 percent in the third quarter, while construction wages increased 0.6 percent.

Benefits for all workers increased 0.8 percent in the July-September quarter after rising 0.6 percent in the second quarter. They were up 2.4 percent in the 12 months through September. (Reporting by Lucia Mutikani; Editing by Andrea Ricci)