By Lucia Mutikani

WASHINGTON (Reuters) - U.S. retail sales rebounded in September amid a surge in motor vehicle purchases and rise in discretionary spending, pointing to solid demand that reinforces expectations of an interest rate increase from the Federal Reserve in December.

Other data on Friday suggested a pickup in inflation, with producer prices rising broadly last month to record their biggest year-on-year increase since December 2014. The reports were the latest indication that the economy regained momentum in the third quarter after a lackluster first-half performance.

"Today's data give the Fed a green light to raise interest rates by year-end. Retail numbers were solid and confirm that the economy is moving in what the Fed believes is an acceptable fashion," said David Donabedian, chief investment officer at Atlantic Trust Private Wealth Management in Baltimore.

The Commerce Department said retail sales increased 0.6 percent after declining 0.2 percent in August. Sales were up 2.7 percent from a year ago.

Excluding automobiles, gasoline, building materials and food services, retail sales edged up 0.1 percent last month, reversing August's 0.1 percent drop. These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product.

Though the small gain in core retail sales last month suggests a moderation in consumer spending from the second quarter's robust 4.3 percent annualized rate, economists said they expected consumption grew at around a still solid 2.8 percent pace in the third quarter.

"Overall, the details of the report are more positive than what the modest print on core sales suggests," said Brittany Baumann, an economist at TD Securities in Toronto. "Together with healthy levels of consumer sentiment and continued improvement in labor market conditions, today's report is enough to keep a December Fed rate hike firmly on the table."

Economists had forecast overall retail sales increasing 0.6 percent and core sales advancing 0.4 percent last month.

The dollar rose against a basket of currencies on the data, while prices for U.S. government debt fell. U.S. stocks were trading higher, also boosted by better-than-expected quarterly profits from JPMorgan, Citigroup and Wells Fargo.

INFLATION RISING

A second report from the University of Michigan showed consumer sentiment softened in early October amid uncertainty over the U.S. presidential election on Nov. 8, with the campaign taking a more acrimonious tone.

"It is likely that the uncertainty surrounding the presidential election had a negative impact, especially among lower-income consumers, and without that added uncertainty, the confidence measures may not have weakened," the University of Michigan said in a statement.

Minutes of the Fed's Sept. 20-21 policy meeting published on Wednesday showed several officials believed it would be appropriate to increase interest rates "relatively soon" if the economy continued to gain strength.

The U.S. central bank raised its benchmark overnight interest rate last December and has held it steady since, largely because of concerns over low inflation.

But inflation is steadily rising. In a third report, the Labor Department said its producer price index for final demand increased 0.3 percent last month after being unchanged in August. In the 12 months through September, the PPI jumped 0.7 percent, the biggest increase since December 2014. The PPI was flat in the 12 months through August.

A 0.7 percent increase in the cost of goods, including energy, accounted for more than three quarters of the rise in final demand prices.

Producer prices are gaining as some of the drag from the dollar's past surge starts to ease. The dollar rally appears to have peaked early this year and oil prices having pushed off multi-decade lows, which economists expect could allow inflation to gradually rise toward the Fed's 2 percent target.

The retail sales report added to upbeat data on the labor market and manufacturing and services sector surveys that have suggested economic growth picked up in the third quarter.

Growth estimates for the third quarter are currently as high as a 2.6 percent rate. The economy grew at a 1.4 percent pace in the second quarter.

September's retail sales were boosted by a 1.1 percent jump in auto sales. There were also strong increases in sales at furniture and building material stores. Online sales also rose, cutting into sales at the traditional department stores, which left receipts at clothing outlets flat.

Sales at restaurants and bars advanced 0.8 percent, the largest gain since February, and receipts at sporting goods and hobby stores surged 1.4 percent, pointing to strong discretionary spending.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)