Gold drops on dollar rise as U.S. data supports rate-hike prospect

By Marcy Nicholson and Clara Denina

NEW YORK/LONDON (Reuters) - Gold fell on Friday as the dollar rose after U.S. economic data came in within analysts' expectations, cementing assumptions of an interest rate increase by the Federal Reserve by year-end.

U.S. retail sales rebounded 0.6 percent in September while producer prices also rose broadly to record their biggest year-on-year increase since December 2014.

The dollar gained 0.4 percent against a basket of six major currencies.

Spot gold was down 0.3 percent at $1,254.26 an ounce by 2:12 p.m. EDT (1812 GMT). U.S. gold futures settled down 0.2 percent, at $1,255.50.

Later in the session, Federal Reserve Chair Janet Yellen gave a broad review of where the U.S. economic recovery may still fall short.

"While Yellen did point out some of the longer-term reasons for keeping interest rates lower than in previous cycles, she importantly didn't give any indication that she is opposed to the market interpreting recent Fed communications as signalling a rate hike is imminent this year," said Royce Mendes, director and senior economist at CIBC Capital Markets in Toronto, adding that the bank still expects a rate hike in December.

Earlier, Boston Fed President Eric Rosengren said that investors were probably right in placing "very high" odds on a U.S. interest rate increase in December.

Markets are pricing in around a 70 percent chance that the Fed will move.

Gold is highly sensitive to increases in U.S. interest rates, which can lift the opportunity cost of holding non-interest-bearing gold.

"We are in the midst of one of those large Fed-related moves - we saw an almost $100 upswing in June and July and we are now seeing a $100 decline in September and October as markets see a Fed rate hike coming in," ING Bank senior strategist Hamza Khan said.

Holdings of the SPDR Gold Trust , the world's largest gold-backed exchange-traded fund, rose 0.28 percent to 961.57 tonnes on Thursday.

Among other precious metals, spot palladium was up 1.3 percent at $646 an ounce after touching a new three-month low of $629.22.

"Interest by investors to buy palladium has been muted this year; large ETF outflows are evidence of this," said UBS Wealth Management Research in a note.

"However, we expect this trend to reverse in coming months, sparked by greater concerns about a deeper market deficit as industrial activity lifts further and mine supply struggles to respond."

Silver was down 0.05 percent at $17.44, while platinum rose 0.1 percent at $937, on track for its third weekly fall.

(Reporting by Marcy Nicholson; Editing by Bernadette Baum)