* Consumer prices rise 0.4 percent on gasoline and food
* Year-on-year gain biggest since October 2008
* Core CPI up just 0.2 pct, real earnings fall 0.3 pct
* Strengthening labor market buoys consumer morale in May (Adds comments color, updates markets)
By Lucia Mutikani
WASHINGTON, May 13 Gasoline and food prices hoisted U.S. inflation to a 2-1/2-year high in April, but there was little sign of a broader pick-up in consumer prices that would trouble the Federal Reserve.
The pace of food and fuel price rises slowed considerably from March, suggesting inflation pressures may be peaking.
That, along with a strengthening labor market, lifted the spirits of consumers who have been battered by rising prices.
But the rapid rise in inflation has left wages trailing and many Americans are worried about the squeeze on their personal finances, a survey found.
Consumer prices rose 0.4 percent in April, slowing from 0.5 percent in March, the Labor Department said on Friday.
The rise, which was in line with economists' expectations, took the year-on-year inflation reading to 3.2 percent, the highest since October 2008.
Stripping out volatile food and energy costs, core CPI rose a mild 0.2 percent from March. The 12-month increase at 1.3 percent was at its highest level since February 2010. The Fed, however, would like to see that closer to 2 percent over time.
"The report raises no red flags for the Fed of an unruly inflationary dynamic taking hold," said Julia Coronado, North America chief economist at BNP Paribas in New York.
"Surging headline inflation has taken some steam out of economic momentum of late which would leave the Fed more inclined to be cautious in removing accommodation."
Year-on-year core CPI has risen 0.7 percentage point from a record low of 0.6 percent in October, an increase Fed officials will keep an eye on as they decide when to tighten policy.
Separately, the Thomson Reuters/University of Michigan's index of consumer sentiment rose to 72.4 from 69.8 in April. The surveys also showed consumers were less worried about inflation over the next year.
INSTANT VIEW [ID:nN13143525]
Graphic - US inflation and wage growth:
Graphic - US inflation: Core CPI rose at faster pace
Graphic - U.S. consumer sentiment, inflation:
The stiff rise in food and energy costs in recent months has squeezed consumers, who are seeing only tepid wage gains.
Average hourly earnings, when adjusted for inflation, fell 0.3 percent in April -- declining for a third straight month. In the 12 months to April, they dropped 1.2 percent.
The sentiment survey showed a quarter of respondents reported declining incomes, and almost a third said rising prices had lowered their living standards.
Many Americans are cutting spending to cope with rising prices.
John Bedell, 38, an architect living in Boston said he often brings his lunch to work and borrows movies and books from a public library rather than buy them. He also recently cut his cable package.
Kathy Wismer, a 45-year-old equine enthusiast from Baldwin City, Kansas, has parked her horse trailer and pickup truck in the barn. She said she and her husband are planning to save more this summer ahead of what may be harder times ahead.
"I think the economy is turning around, but I don't think there is any quick fix," she said.
Data on Thursday showed high food and energy prices diverted spending from other areas in April as retail sales posted their smallest rise in nine months. For details see [ID:N12296928]
Last month, rising costs for housing, cars and trucks boosted core CPI. Prices for new vehicles rose 0.7 percent, reflecting lean inventories as a shortage of parts following the earthquake and tsunami in Japan disrupts production.
U.S. Treasury debt prices rose on the inflation report, while stocks fell. Strong growth data in Germany and France boosted the euro against the dollar.
The U.S. central bank has pumped massive amounts of money into the economy, in part to prevent a damaging downward spiral in prices. Its focus is now shifting to how best to eventually withdraw some of the monetary stimulus.
With commodity prices dropping sharply in recent days, economists said headline inflation was close to peaking, which would lessen the risk of broader price pressures building.
"Given what has gone on with commodity prices lately it's likely to represent a peaking in near-term inflation pressures. You are going to see a rollover in the coming months," said Brian Levitt, an economist at OppenheimerFunds in New York.
"Inflation pressures as a whole throughout the the economy remain modest."
Gasoline prices accounted for almost half of the rise in overall consumer inflation last month, advancing 3.3 percent.
The pace of increase, however, slowed from March's 5.6 percent rise and further declines are likely. U.S. gasoline futures RBc1 posted their sharpest daily drop since September 2008 on Wednesday. They edged up on Friday. (Additional reporting by Richard Leong in New York, Lauren Keiper in Boston and Carey Gillam in Kansas City; Editing by Chizu Nomiyama)