By Lucia Mutikani
WASHINGTON (Reuters) - U.S. producer prices in December recorded their biggest fall in more than three years on tumbling energy costs while underlying inflation pressures were tame, a cautionary note for the Federal Reserve as it ponders its next step on monetary policy.
Other data on Thursday showed the number of Americans filing claims for unemployment benefits increased to a four-month high last week. That, however, does not alter the improving jobs market landscape as the data is hard to adjust for seasonal variations around this time of the year.
"That makes the Fed's job more difficult," said Gus Faucher, senior economist at PNC Financial Services Group in Pittsburgh. "We expect inflation to slow ... the Fed needs to be more cautious about raising interest rates."
The Labor Department said its producer price index for final demand declined 0.3 percent, the biggest drop since October 2011, after falling 0.2 percent in November.
In the 12 months through December, producer prices increased 1.1 percent, the smallest gain since November 2013, after rising 1.4 percent in November.
A broader measure of underlying producer inflation pressure that excludes food, energy and trade services edged up 0.1 percent after being flat in November. It was up 1.3 percent in the 12 months through December.
Fed officials have largely viewed the energy-driven weakness in inflation as transitory. But with retail sales and average hourly earnings, another key inflation measure, falling in December, that could give pause to some policymakers.
The U.S. central back has kept its short-term interest rate near zero since December 2008. Most economists expect the first interest rate hike in June. Interest rate futures have pushed bets into the second half of this year, but continue to point to the first rate hike in October.
BELOW TARGET
Inflation is running below the Fed's 2 percent target. Consumer inflation data on Friday is expected to show price pressures remaining muted in December.
In a second report, the Labor Department said initial claims for state unemployment benefits rose by 19,000 to a seasonally adjusted 316,000 for the week ended Jan. 10.
Economists, who had forecast claims falling to 291,000 last week, shrugged off the increase.
"Seasonal adjustments become particularly difficult around year-end. We expect claims to resume their downward trend in the coming weeks and reflect broader improvement in labor markets," said Jesse Hurwitz, an economist at Barclays in New York.
The four-week moving average of claims, considered a better measure of labor market trends as it irons out week-to-week volatility, remained below 300,000, which is associated with a firming labor market, for an 18th straight week.
Other reports showed mixed fortunes for manufacturing in New York state and the mid-Atlantic region in January. Economists said this was broadly in line with some cooling in factory activity in response to slowing global demand and a strong dollar.
Prices for U.S. Treasury debt rose on the data, with the yield on the benchmark 10-year bond falling to a 20-month low. The dollar rallied against the euro after the Swiss National Bank abandoned a three-year-old cap against the single currency.
U.S. stocks were trading marginally lower.
Wholesale energy prices dropped a record 6.6 percent in December, declining for a sixth straight month, reflecting falling crude oil prices against the backdrop of weakening global demand and increased shale production in the United States.
A strong dollar, as the domestic economy outperforms its global peers, is also helping to curb inflation.
Concerns about global growth have also undercut copper prices. On Thursday, copper rose on a mix of bargain-hunting, short-covering and hedging by consumers, a day after its biggest slide in more than three years, but more losses were expected.
(Reporting by Lucia Mutikani; Editing by Paul Simao)
