By Lucia Mutikani
WASHINGTON (Reuters) - U.S. consumer prices increased in December as households paid more for gasoline and rental accommodation, leading to the largest year-on-year increase in 2-1/2 years and signaling that inflation pressures could be building.
The rise in inflation, coming as economic growth strengthens, was corroborated by a separate report on Wednesday from the Federal Reserve, which said pricing pressures "intensified" somewhat from late November through the end of 2016.
The trend, if sustained, may push the U.S. central bank to raise interest rates at a faster pace than currently anticipated. The Fed has forecast three rate hikes this year.
"Further momentum in consumer prices could add to the perception of a more hawkish Fed and the potential for more aggressive tightening," said Jim Baird, chief investment officer at Plante Moran Financial Advisors in Kalamazoo, Michigan.
The Labor Department said its Consumer Price Index rose 0.3 percent last month after a 0.2 percent gain in November. In the 12 months through December, the CPI increased 2.1 percent, the biggest year-on-year rise since June 2014. The CPI rose 1.7 percent in the year to November.
The gains were in line with economists' expectations. The CPI increased 2.1 percent in 2016, up from a gain of 0.7 percent in 2015. The Fed raised its benchmark overnight interest rate by 25 basis points to a range of 0.50 percent to 0.75 percent last month.
Fed Chair Janet Yellen suggested on Wednesday that she supported further rate increases.
"Waiting too long ... could risk a nasty surprise down the road - either too much inflation, financial instability, or both," Yellen said in remarks prepared for delivery to the Commonwealth Club of California in San Francisco.
The dollar rebounded from a near six-week low against a basket of currencies on Yellen's comments and the inflation data. Prices for U.S. Treasuries fell, with the yield on the 30-year bond rising to 3 percent. U.S. stocks ended mostly higher.
The so-called core CPI, which strips out food and energy costs, rose 0.2 percent last month after the same increase in November. As a result, the core CPI was up 2.2 percent in the 12 months through December, from 2.1 percent in November.
The Fed has a 2 percent inflation target and tracks an inflation measure which is currently at 1.6 percent. Rising wages due to a tightening labor market also are contributing to higher inflation.
Average hourly earnings increased in December at their quickest pace since June 2009, a government report showed earlier this month.
The Fed's latest Beige Book, a collection of anecdotal information from businesses, showed eight of the central bank's 12 districts reported modest price increases from late November through the end of December.
"Pricing pressures intensified somewhat since the last report," the Fed said. "Increases in input costs were more widespread than increases in final goods prices. Businesses in several districts reportedly expect further modest increases in input costs and selling prices in 2017."
Inflation could also get a boost from an expected fiscal stimulus from the incoming Trump administration. Donald Trump, who will be sworn in as U.S. president on Friday, has pledged to increase infrastructure spending and cut taxes.
"There is nothing here to dissuade the Fed from picking up its rate hike pace this year," said Michael Gregory, deputy chief economist at BMO Capital Markets in Toronto.
GASOLINE PRICES CLIMB
Underscoring the economy's momentum, another report from the Fed on Wednesday showed industrial production rose 0.8 percent in December, the biggest gain since November 2014, after falling 0.7 percent in the prior month.
Output was driven by a surge in the utilities production as well as an increase in manufacturing.
"The small gain in manufacturing, the third of the past four months, is a positive sign from a sector that has moved sideways over much of the past two years," said Andrew Labelle, an economist at Citigroup in New York. "The pickup in commodity prices is clearly providing a lift to manufacturing."
The consumer inflation report showed gasoline prices climbed 3.0 percent last month after advancing 2.7 percent in November.
Housing also continued its upward march in December. Rental costs increased 0.3 percent last month, with owners' equivalent rent of primary residence also rising 0.3 percent. Rents rose 4.0 percent in 2016.
Consumers also paid more for healthcare last month, with prices for prescription medicine and hospital services rising.
There were also cost increases for a range of other goods and services, including motor vehicle insurance and airline fares. Prices for used cars and trucks rose solidly.
But households got some respite at supermarkets and department stores. Food prices were unchanged for a sixth straight month, with the cost of food consumed at home dropping for an eighth consecutive month. Apparel prices fell for a second straight month in December.
(Reporting by Lucia Mutikani; Additional reporting by Lindsay Dunsmuir; Editing by Paul Simao)