US RATE FUTURES-See little chance of Fed hike on horizon

By Ros Krasny

CHICAGO, Aug 19 (Reuters) - U.S. short-term interest rate futures on Tuesday marked down the prospects for Federal Reserve rate hikes after a higher than expected reading on wholesale prices and a tumble in housing starts in July.

The implied prospects for a Federal Reserve rate hike in September are 12 percent against 16 percent late on Monday, and those for a hike by year-end slipped to 28 percent from 36 percent.

With the U.S. economy still struggling, a quarter-point Fed rate hike from the current 2 percent fed funds rate is not fully priced in futures until the second quarter of 2009.

The Labor Department said core producer prices, or those stripped of food and energy costs, jumped by 0.7 percent in July, far above the 0.2-percent consensus, and the largest increase since November 2006.

The headline year-on-year PPI increase of 9.8 percent was the largest since June 1981.

"The data will be taken as a sign that underlying price pressures were hitting the finished goods stage, and that the recent decline in commodities may not save the day completely on the inflation front," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

Still, coming several days after the closely-watched consumer price index also flashed an inflation warning sign, the impact of the PPI data was muted.

"The market has ... dismissed it as backwards-looking giving the recent downtrend in commodity prices," fixed-income strategists at 4CAST Ltd said in a research note.

Dealers also looked at the July housing starts report as a sign that the housing market, seen as a key to a U.S. economic recovery, remains weak.

July starts were made at a 965,000 unit annual rate, above the consensus forecast but down from June's 1.084 million rate.

"The underlying trend is still downward. The fundamentals in housing are still poor," said Dana Saporta, economist at Dresdner Kleinwort Securities LLC in New York.

(Additional reporting by Richard Leong, Editing by Chizu Nomiyama)