U.S. producer prices post biggest drop in three years

U.S. producer prices in December recorded their biggest fall in more than three years on

tumbling energy costs, while underlying inflation pressures were muted, a cautionary note for the Federal Reserve as it ponders its next step on monetary policy.

The Labor Department said on Thursday 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. Economists polled by Reuters had forecast the PPI dropping 0.4 percent in December and increasing

1.0 percent from a year ago.

Fed officials largely view the energy-driven weakness in inflation as transitory. But with 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, but U.S. futures traders have cut their bets to the second half of this year in the wake of

Wednesday's weak retail sales report.

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.

Last month, wholesale energy prices dropped a record 6.6 percent after falling 3.1 percent in November.

They have now declined 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. Wholesale food prices fell 0.4 percent after slipping 0.2 percent in November.

A broader measure of underlying producer inflation pressure, which 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.

((Reporting by Lucia Mutikani; Editing by Paul Simao))