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WASHINGTON (Reuters) - U.S. producer prices advanced sharply last month on higher energy costs, spelling more problems for the economy and lowering the prospects for another steep Federal Reserve interest rate cut.

In addition, a gauge of factory conditions in the New York region was stronger than expected, but signals from the housing market show conditions there remain glum.

Prices received by U.S. farms, factories and refineries rose 1.1 percent in March, almost twice the pace economists had estimated and the largest gain since November, Labor Department data showed on Tuesday. But core prices, which strip out volatile food and energy costs, showed a more-subdued 0.2 percent rise.

Federal Reserve policy-makers have slashed interest rates to shield the economy from a housing crisis that has chilled growth. They are expected to cut rates again later this month, but Tuesday's inflation data indicated the cut may only be a quarter percentage point, smaller than analysts have forecast.

"The report will remove expectations that the Fed will cut 50 basis points at the next meeting," said Ron Simpson at Action Economics in Tampa, Florida, referring to the Fed's upcoming policy gathering on April 29-30.

"The market right now is aware that there are inflation problems in the U.S. and at some point, the Fed needs to show its inflation-fighting credentials," he said.

Producer prices were released on the day that oil hit a record high on U.S. futures markets of $114.07 a barrel. Soaring energy costs are expected to crimp the budgets of Americans already hit by fallout from the troubled housing sector.

An April measure of home builder sentiment hovered near all-time lows, despite the arrival of the traditional spring house-buying season.

The NAHB/Wells Fargo Housing index was unchanged at 20 for the third straight month. Readings below 50 mean that more builders view market conditions as poor than favorable.

A separate report from real estate data firm RealtyTrac showed U.S. home foreclosure filings jumped 57 percent in the year to March, with bank repossessions up 129 percent -- a reminder of the cloud housing has cast.

The dollar edged up on the producer price data as investors bet this would make the Fed more wary of aggressively cutting interest rates.

U.S. Treasury debt prices retreated, with the benchmark 10-year note down 21/32 in price for a yield of 3.6 percent. Stocks made modest gains and the Dow Jones Industrial Average closed 60 points higher at 12,362.

The U.S. central bank has cut rates by 3 percentage points since mid-September. Prices of interest rate futures fully imply another quarter-point cut in rates later this month, but have now scaled back the likelihood of a deeper move.

FACTORIES BRIGHTEN

The New York Federal Reserve Bank's "Empire State" business conditions index -- a gauge of regional factory activity that offers one of the freshest readings on U.S. manufacturing -- rose to plus 0.63 in April from minus 22.23 in March. Economists had expected it to edge up to only minus 17.5.

Fed policy-makers must balance the fallout from the housing downturn on growth with their duty to keep inflation at bay.

Economists had forecast producer prices -- largely a gauge of prices at the wholesale level -- would rise 0.6 percent last month after a 0.3 percent gain in February. Energy prices were up 2.9 percent and food goods gained 1.2 percent.

On a year-on-year basis, producer prices rose 6.9 percent, while core prices increased by 2.7 percent -- the largest 12-month gain since July 2005.

"There are still a lot of inflation pressures out there," said T.J. Marta, fixed income strategist at Royal Bank of Canada Capital Markets in New York.

Energy prices have risen 20.4 percent over the past year, with gasoline up 36.4 percent and heating oil up 52 percent.

During the first quarter of 2008, producer prices rose 10.2 percent on an annual basis, moderating slightly from the 11.5 percent pace of the previous three months after gains in energy prices slackened a touch, the Labor Department said.

"Inflation data continues to be dominated by rising energy prices. Unfortunately for the Federal Reserve, they cannot simply say that high energy prices are temporary," said Tom Sowanick at Clearbrook Financial LLC in Princeton, New Jersey.

(Additional reporting by Chris Reese, Lynn Adler, John Parry and Richard Leong in New York, Editing by Neil Stempleman)


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This will severely curtail the Fed's ability to cut interest rates later this year, if this trend continues.