Where Is Inflation?

NEW YORK (Reuters) - A U.S. bond market gauge on investors' inflation expectations fell early Wednesday after a government index on domestic consumer prices unexpectedly declined for the first time in nearly 1-1/2 years due to a broad decrease in energy prices.

Inflation break-even rates, the yield differences between U.S. Treasury Inflation Protected Securities and regular Treasury securities, shrank in reaction to the latest reading on the Consumer Price Index, which fell 0.2 percent last month. Analysts had forecast no change in the index.

The 10-year TIPS break-even rate fell to its lowest level in about a year in advance of a $13 billion auction of this bond's maturity on Thursday, analysts and traders said.

The price of the iShare TIPS exchange traded fund, which with more than $13 billion in assets is the largest ETF of its type, fell 0.2 percent to $112.52 a share, a more than five-month low.

The CPI's surprise fall came as traders have been speculating whether Federal Reserve policymakers might signal intentions to begin raising the federal fund rate target from its near-zero level in the latter half of 2015.

The central bank's Federal Open Market Committee will release its latest policy statement at 2 p.m. EDT, followed by a press conference with Fed Chair Janet Yellen a half-hour later.

Some analysts have said the U.S. central bank would probably not raise rates sooner, partly because domestic inflation, while rising this year, is still falling short of its 2 percent target.

"Today's CPI report has significantly weakened the positions of those who are hawkish," said Aaron Kohli, an interest rate strategist at BNP Paribas in New York.

On a year-over-year basis, the core CPI, which excludes volatile food and energy prices, was up 1.7 percent in August, less than July's 1.9 percent increase.

The five-year inflation break-even rate was last quoted at 1.75 percent, down 6.5 basis points from late on Tuesday and which Kohli said was the lowest since December.

The 10-year inflation break-even rate was last at 2.08 percent, down 4 basis points from Tuesday's close. Kohli said that was the lowest since September 2013.

TIPS have struggled recently. Barclays' index on their performance showed a 1.86 percent loss so far in September, reducing its year-to-date return to 4.34 percent.