By Corbett B. Daly and Emily Kaiser
WASHINGTON (Reuters) - Inflation slowed more than expected in September even as retail sales picked up, keeping pressure on the Federal Reserve to act soon to lessen the risk of a downward price spiral.
Federal Reserve Chairman Ben Bernanke signaled on Friday the central bank would likely pump more dollars into the sagging economy, and the prospect of more easy money threatened to exacerbate global tensions about currency policies.
The U.S. consumer price index rose 0.1 percent in September and the core index, which excludes volatile food and energy prices, remained unchanged for the second straight month, data released by the Labor Department showed.
Core prices were up just 0.8 percent in the 12 months through September, the smallest rise since 1961.
"If anything that may make (the Fed) more likely to embark on asset purchases, and that may mean they're going to be more aggressive with those asset purchases," said Richard Bryant, head of treasury trading at MF Global Securities in New York.
Longer-dated U.S. Treasury prices fell on views the Fed would try to create inflation. U.S. stock indexes were mixed while the dollar recovered after hitting its lowest in more than eight months against the euro.
DEFLATION RISK
A prolonged drop in prices would likely lead consumers to put off purchases and businesses to cancel investments, compounding economic woes that are already weighing heavily on U.S. President Barack Obama and his fellow Democrats ahead of November 2 congressional elections.
At a speech in Boston, Bernanke said high unemployment and low inflation point to a need for a further easing of U.S. monetary policy, but he offered no details on the central bank's next step.
Investors expect the Fed could pump billions of dollars into the economy as soon as next month in a second major round of "quantitative easing" aimed at supporting the recovery.
"(This) gives the Fed room to do whatever it wants to do," said Jim Awad, managing director at Zephyr Management in New York.
Casting further doubts about the pace of the U.S. recovery, General Electric Co posted a sharper-than-expected drop in revenue.
Ongoing U.S. economic weakness and the prospect of further dollar printing are creating headaches around the world as yield-hungry investors rush into emerging markets.
That has led currencies like the Brazilian real to soar, making it harder to export goods to the U.S. market. ECB policymaker Jose Manuel Gonzalez-Paramo said instability in foreign exchange markets was bad but denied major economies were embroiled in a currency war, as Brazil has alleged.
At the same time, Friday's data did hold some glimmers of hope for U.S. economy. Sales at U.S. retailers rose by a stronger-than-expected 0.6 percent in September, suggesting consumption may have been a bit stronger than economists had anticipated in the third quarter.
Also, inventories at U.S. businesses rose strongly in August, while the New York Fed's "Empire State" business index showed factory in New York State jumped during October.
"Retail sales and the Empire State index were strong, suggesting the economy is indeed improving. But inflation remains low and troubling," said Hugh Johnson, chief investment officer at Hugh Johnson Advisors in Albany, New York.
The economy, which slowed sharply in the second quarter, has kept the pressure on the Democratic party, which looks likely to lose control of the U.S. House of Representatives in November 2 elections.
U.S. consumer sentiment unexpectedly dipped in early October to its weakest level since July, while consumers' assessments of government economic policies fell to the lowest level since Obama took office, a separate survey released on Friday showed.
(Additional reporting by Caroline Valetkevitch, Ryan Vlastelica, Emily Flitter, Wanfeng Zhou and Rodrigo Campos in New York and by the New York Economics and Markets Desk; Writing by Jason Lange; Editing by Andrea Ricci and Neil Stempleman)