By Eric Morath

WASHINGTON -- The Federal Reserve's preferred measure of inflation rose last month to the strongest reading in more than two years, providing fresh evidence of firming prices a day before policy makers meet to discuss the path of interest rates this year.

The personal-consumption-expenditures price index advanced 0.2% in December from the prior month, the Commerce Department said Monday. The measure of consumer inflation rose 1.6% from a year earlier, a 12-month increase last seen in September 2014. The reading was last higher in July that year.

The report also showed consumer spending increased solidly last month, with strong year-end car sales and higher utility spending with the return of seasonably cool temperatures. Meanwhile, incomes grew more modestly than spending, cutting the share of earnings Americans saved.

The annual inflation reading remains below the Fed's 2% target, but the PCE index has accelerated from nearly flat just more than a year ago. And there are signs that may continue.

"Inflation will gradually accelerate over the next couple of years due to higher energy prices and stronger wage growth that leads firms to raise prices," PNC Bank economist Gus Faucher said.

Rising gasoline prices are pushing the overall gain to line up with inflation recorded for the past year outside of the volatile food and energy categories. The so-called core inflation index increased 0.1% in December and rose 1.7% from a year earlier. The inflation figure excluding food and energy has held near that level since the start of 2016.

The steady but slow climb in consumer prices isn't likely to spur the Fed to act on its benchmark interest rate this week. A two-day policy meeting starts Tuesday. But rising prices do give the central bank more leeway to bump up interest rates later this year, with the unemployment rate at historically low levels.

The central bank has raised its key rate just once in each of the past two years but indicated in December that three increases could be in order this year.

"This rise in inflation was anticipated and largely represents a fading of the effects of earlier declines in energy prices and the prices of nonenergy imports," Fed Chairwoman Janet Yellen said in a speech this month. "In addition, slack in labor and product markets is no longer placing downward pressure on inflation, in contrast to the situation only a few years ago."

The pace of price increases is expected to remain modest. A forecast of inflation over the next year from the Federal Reserve Bank of Dallas,updated after the Commerce Department's report, projected a 1.8% increase, where the reading has stood since October.

In December, Fed policy makers' median projection for annual headline inflation in late 2017 was 1.9%.

The Commerce Department report showed consumer spending rose 0.5% in December from November. Incomes advanced 0.3% during the month. The figures show outlays picked up after a fall slowdown. But when adjusting for inflation, spending rose 0.3% last month.

To support better spending, Americans saved a smaller share of their income last month. The personal saving rate fell to 5.4% from 5.6% in the prior month. December's saving rate was the lowest since March 2015.

"The gradual downward trend in the household savings rate confirms that households were on a solid footing by the end of the fourth quarter and precautionary savings are not a concern," Barclays economist Blerina Uruci said.

Inflation-adjusted disposable personal income -- income after taxes -- was up 0.1% in December after holding flat in November.

Consumer spending accounts for about two-thirds of total economic output in the U.S., and household outlays have been the main driver of economic growth throughout much of the expansion. Slower consumer-spending gains in the fourth quarter contributed to a deceleration of overall economic growth to a 1.9% pace from a 3.5% increase in the third quarter, according to a Commerce Department report on gross domestic product released last week.

Last week's report incorporated the December spending data released in more detail Monday.

Outlays on long-lasting goods, such as cars and appliances, rose sharply in December, while spending on goods that are used more quickly, including gasoline and clothes, increased slightly. Spending on services maintained the same pace recorded for much of 2016.

Spending for November wasunrevised at a 0.2% gain. Incomes rose 0.1% that month, revised up from a previous estimate of unchanged.

Write to Eric Morath at eric.morath@wsj.com

(END) Dow Jones Newswires

January 30, 2017 17:33 ET (22:33 GMT)

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