Gold rises after unexpected drop in U.S. inflation

By Marcy Nicholson and Jan Harvey

NEW YORK/LONDON (Reuters) - Gold rallied more than 1 percent on Wednesday after data showing a surprise drop in U.S. inflation last month dented expectations that the Federal Reserve this week will decide to increase interest rates for the first time in nearly a decade.

U.S. consumer prices (CPI) unexpectedly fell in August, pointing to tame inflation that complicates the Fed's decision whether to raise rates.

That helped gold to break out of the narrow range it has held ahead of the Fed's two-day policy meeting that began on Wednesday, to a one-week high at $1,124.30.

"The tame CPI numbers have caused gold shorts, who were hoping in vain for a test under $1,100, to cover ahead of tomorrow's Fed decision," said Tai Wong, director of base and precious metals trading for BMO Capital Markets, adding that the price index number is "incrementally more likely to keep the Fed on hold."

"The dot plot is likely to move down in any case, so if the Fed doesn't hike, it will be extra dovish."

Spot gold was up 1.3 percent at $1,119.70 an ounce at 1:57 p.m. EDT (1757 GMT), while U.S. gold futures for December delivery settled up 1.5 percent at $1,119 per ounce.

Silver prices were up 3.4 percent at $14.88.

"CPI came in weaker than expected," Heraeus trader Alexander Zumpfe said. "Markets took that as a kind of confirmation that the Fed won't hike interest rates tomorrow, since there is no reason inflation-wise."

A little over half the 80 economists polled by Reuters over the last 24 hours said they expect the Fed to hold fire on a rate rise for slightly longer.

A hike is expected to pressure gold.

"I see three options: no change, rate hike with a hawkish statement or rate hike with a dovish statement," Saxo Bank's head of commodity research Ole Hansen said.

"The first two will be gold-negative while the last (which is my preferred option) could trigger a recovery as it removes the uncertainty and should keep the dollar from rising too fast."

Global stock prices rose for a second day while the dollar fell. [MKTS/GLOB]

On the physical gold markets, prices in India were at a discount of about $5 an ounce to the global benchmark due to sluggish demand, dealers said, while they were around a $5 premium in China. [GOL/AS]

Platinum was up 1 percent at $966.49 an ounce and palladium was up 1.1 percent at $606 per ounce.

(Additional reporting by A. Ananthalakshmi in Singapore; Editing by Jason Neely and Chizu Nomiyama)