Fed seen on hold until September, with rising bets on earlier rate cut

By Ann Saphir

(Reuters) -The Federal Reserve will likely wait until September before cutting its policy rate, traders bet on Thursday, as data kept alive worries over elevated inflation and a decline in jobless claims suggested the labor market remains healthy.

Even so, the specific elements that drove the 0.4% rise last month in the producer price index -- versus economists' expectation for a 0.3% gain -- gave some reason to expect improvement in the measure that the Fed uses to track inflation.

Several analysts crunching the data along with Wednesday's report of a surge in consumer prices in January say they now estimate underlying year-over-year personal consumption expenditure price inflation rose 2.6% or 2.7% in January, down from 2.8% in December.

"The Fed still can declare, therefore, that progress in returning inflation to its 2% objective is still being made," Pantheon economist Samuel Tombs wrote, one of several Wall Street analysts making a similar point.

Financial markets reflected that view as well, with the market-based probability of a July rate cut rising to just shy of even odds, from only about 40% earlier. A September rate cut is still seen as more likely.

Fed policymakers last month kept their policy rate in the 4.25%-4.50% range. Fed Chair Jerome Powell said this week he feels policy needs to stay restrictive until there is better progress on bringing down inflation.

Central bankers also have their eye on any signs of weakness in the labor market that could trigger an interest rate cut.

On Thursday, a separate government report showed the number of Americans filing new applications for unemployment benefits fell last week, suggesting the labor market remained stable early in February.

(Reporting by Ann Saphir with reporting by Lucia Mutikani, Howard Schneider, Dan Burns; Editing by Chizu Nomiyama)