Higher gasoline prices and airline fares helped nudge consumer prices a modest 0.3 percent higher in July, the Labor Department reported yesterday, in line with expectations and a further sign that inflation remains muted in a vibrant economy.

The July increase in the consumer price index was the first in three months. The "core" index, which excludes the volatile food and energy components, rose 0.2 percent after increases of 0.1 percent in both May and June.

Financial markets rallied after the report was released. The Dow Jones industrial average gained more than 50 points in the first few minutes of trading and ended the day up 70.29, at 11,117.08. The price of the benchmark 30-year U.S. Treasury bond rose $10.63 per $1,000 invested, with its yield, which moves in the opposite direction, falling to 6.01 percent, from 6.08 percent late Monday.

Economists cheered the news, the last significant economic report before Federal Reserve policymakers meet next week to decide whether to raise interest rates.

"It kind of underscores the notion that inflation remains pretty subdued right now," said David Resler, an economist at Nomura Securities Co. "There's really not much deviation from recent trends."

While some said they still expect Fed officials to raise interest rates next Tuesday, there was hope that the latest batch of benign inflation numbers will persuade Fed policymakers to stop at just one more rate increase. At their last meeting June 30, the policymakers raised their target for the overnight bank lending rate to 5 percent from 4.75 percent.

But Stephan Thurman, deputy chief economist at the U.S. Chamber of Commerce, said the latest inflation numbers mean Fed Chairman Alan Greenspan and his colleagues need not raise rates next week.

"Mr. Greenspan, where's the inflation?" Thurman said. "They don't have a justification, much less an excuse."

Partly in anticipation of Fed action, market interest rates have been on the rise in the past few months, and some analysts said the increase in mortgage and other borrowing costs will eventually bring about the slowdown in the economy desired by the Fed.

"It looks like we may be developing a scenario where they tighten a little bit next week and that's all," said William Kirby, a senior bond trader at Prudential Securities Inc. "The market has done a lot of tightening for the Fed already."

So far this year, the consumer price index has risen at an annual rate of 2.4 percent. While that is 50 percent above last year's 1.6 percent rate of growth, it is still low by historical standards. Much of the increase in the CPI can be attributed to a rebound in energy prices from their 30-year lows of last year.

Energy costs rose 2.1 percent in July, accounting for nearly half of the overall CPI increase. Energy prices are running 12.4 percent higher this year, on an annualized basis, than last year.

July's 6.5 percent rise in air fares surprised some economists, but they suggested it partly reflects increases in fuel costs paid by the airlines.

Food and beverage prices rose 0.2 percent last month after being unchanged in June. Clothing prices fell 0.9 percent after falling 0.4 percent in June.

Other economic reports released today supported the picture of a robust economy that continues to grow despite rising interest rates.

Housing starts rose 5.7 percent in July, to a 1.66 million annual rate, surpassing expectations. That growth occurred despite some economists' expectations that housing starts would slow as interest rates on some 30-year fixed mortgages rose above 8 percent. But building permits--an indicator of future activity--fell marginally, by 0.5 percent.

Industrial production, a key measure of the health of the manufacturing sector, rose 0.7 percent in July, bolstered by strong demand for electricity and air conditioners during a period of drought and record heat throughout much of the country.

The capacity utilization rate, which tracks the amount of available manufacturing capability in use, rose to 80.7 percent in July, which is the highest it's been since late last year. But a reading in the low 80s is still considered good by most economists, providing plenty of room for growth in manufacturing output.

CAPTION: No Surprises (This chart was not available)