By Lucia Mutikani
However, the month-on-month gain was the smallest in three months and so-called core prices, which strip out volatile food and energy costs, edged up just 0.1 percent.
While the report supported the Federal Reserve's contention that price pressures would abate after spiking earlier this year, there was still enough inflation in the economy for the U.S. central bank to worry about, analysts said.
The Fed focuses on core CPI as it tailors monetary policy, but some economists said it could no longer afford to ignore stubbornly high food and gasoline prices.
Food prices rose 0.4 percent in September, a touch slower than the previous month, while gasoline costs accelerated 2.9 percent from 1.9 percent in August.
"It's not enough anymore to look at the core because the long-term trend for food prices is high. It has really become an issue for consumers," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.
With the unemployment rate stuck above 9 percent, wage growth has trailed inflation. While weekly wages adjusted for inflation rose 0.2 percent in September, they were down 1.7 percent from a year ago.
HOUSING STARTS JUMP
The Fed, which has already cut overnight lending rates to near zero and pumped $2.3 trillion into the economy, is searching for more ways to boost growth.
Recent economic data have suggested the U.S. economy fared much better in the third quarter than it did in the first half of the year, lessening the pressure for more monetary stimulus.
In a separate report, the Fed said the economy continued to expand slightly in September but prospects for the future appeared to be dimming.
But other data struck a slightly optimistic note on the economy. The Commerce Department said housing starts rose 15 percent to an annual rate of 658,000 units in September, well above economists' expectations for a 590,000-unit pace.
That jump, however, reflected a big surge in groundbreaking for multifamily dwellings. Single-family home construction -- which accounts for a larger share of the market -- rose just 1.7 percent and permits for future building fell 5 percent, a sign the housing market remains far from recovery.
Another report showed applications for U.S. home mortgages tumbled 14.9 percent last week as demand for both refinancing and purchases fizzled.
The Fed's downbeat assessment of the economy's prospects, pushed U.S. stocks lower. Prices for U.S. Treasury debt recouped earlier losses, while the dollar was little changed against a basket of currencies.
Underlying inflation pressures were restrained last month as the cost of apparel and used vehicles fell, new car prices held steady and rental-related costs rose only modestly. A rolling three-month average of core inflation suggests it peaked earlier this year.
Prices for new motor vehicles were unchanged for a third straight month in September, likely reflecting a normalization in supplies after the March earthquake in Japan disrupted production.
Even though food and gasoline prices remain strong and factories are facing high costs of production, some economists believe consumer inflation will not rise any further, citing the weak economy.
"There is high slack in the economy and consumers are price sensitive," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester Pennsylvania.
"Given that the unemployment rate is 9.1 percent and wages are barely keeping up with inflation, businesses will have to swallow some of those (increased production) costs."
(Additional reporting by Jason Lange; Editing by Andrea Ricci)