* Consumer prices rise 0.7 percent, largest gain since 2009 * Gasoline accounts for about three quarters of rise in CPI * Core CPI increases 0.2 percent, slows from January * Consumer sentiment hit by gasoline, fiscal policy concerns By Lucia Mutikani WASHINGTON, March 15 (Reuters) - U.S. manufacturing output bounced back in February in the latest signal of strength in an economy that is showing clear momentum despite the headwind from government austerity. While other reports on Friday showed a surge in gasoline prices caused a spike in consumer inflation last month and eroded consumer sentiment in early March, the impact on the economy was likely to be limited and temporary. "It appears that real economic growth is on an upswing," said John Ryding, chief economist at RDQ Economics in New York. Factory production increased 0.8 percent last month after falling 0.3 percent in January, the Federal Reserve said. The gain was broad based and double what economists had expected. The increase combined with a big rise in utilities' output to lead overall industrial production up by 0.7 percent, a good sign for first-quarter economic growth after activity stalled at the end of 2012. Data ranging from employment to retail sales have suggested a limited hit on the economy from the end of a 2 percent payroll tax cut and higher tax rates for wealthy Americans, which went into effect at the start of the year. Economists, who had already raised their first-quarter growth forecasts substantially this week, were further encouraged by the rise in factory output. "It had seemed like the economy was going to be leaning primarily on the consumer and housing. We have another leg to stand on with manufacturing kicking in," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. First-quarter GDP growth estimates currently range as high as a 3.0 percent annual rate. The economy grew at only a 0.1 percent pace in the fourth quarter. FED TO HOLD POLICY COURSE Separately, the Labor Department said its Consumer Price Index increased 0.7 percent last month, the largest gain since June 2009, as the cost of gasoline spiked 9.1 percent. The CPI had been flat for the two previous months. Gasoline accounted for about three quarters of the rise in consumer inflation in February, and so-called core prices, subtracting volatile food and energy costs, advanced just 0.2 percent, leaving the door open for the Federal Reserve to press ahead with its bond-buying stimulus. Economists polled by Reuters had expected the CPI to advance 0.5 percent. In the 12 months through February, it was up 2 percent, the largest gain since October and an acceleration from January's 1.6 percent. Core prices also increased 2 percent over the past 12 months, the largest gain since October. However, a separate inflation index the Fed - the U.S. central bank - follows more closely has been falling and hit a nearly two-year low in January. "The way the data has been playing out, it gives them a free hand to be extremely aggressive to bring down unemployment," said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut. Fed officials meet next week to assess the economy and are widely expected to keep purchasing $85 billion in bonds per month to spur even stronger growth. The dollar dropped from a seven-month high against a basket of currencies as the inflation data reinforced expectations the Fed would continue to pump money into the economy. U.S. Treasury debt prices rose, while stocks dropped on corporate news, ending the Dow Jones industrial average's longest winning streak since 1996. CONSUMERS FEELING PINCH The rise in gasoline prices last month was the largest since June 2009 and snapped four straight months of declines. The gasoline-driven spurt in inflation eroded household purchasing power, which could hurt spending. Average hourly earnings adjusted for inflation fell 0.6 percent in February, and were up only 0.1 percent compared with a year ago. But relief is on the way as prices at the pump have declined in the past two weeks. Expensive gasoline and tighter fiscal policy also weighed on consumer morale early this month. The Thomson Reuters/University of Michigan's index of consumer sentiment fell to its lowest level since December 2011. Given the signs of strength in the economy, economists were little disturbed by the drop in sentiment, however. "This drop in consumer sentiment was quite a surprise. I think these numbers will be revised higher later in the month, but consumer confidence remains fragile," said Terry Sheehan, an economist at Stone & McCarthy Research Associates in Princeton, New Jersey. The data on industrial production further bolstered growth expectations. The gain in manufacturing output reflected a big 1.2 percent jump in the production of long-lasting goods, with auto production up a sharp 3.6 percent after a 4.9 percent plunge in January. Even though a separate report from the New York Federal Reserve Bank showed its "Empire State" general business conditions index slipped to 9.24 in March from 10.04 in February, economists were not too concerned. "The Empire index has kicked off March manufacturing surveys on a fairly solid note, suggesting further growth in the manufacturing sector is in store, even if at a slightly less-stellar pace than had been indicated in February," said Gennadiy Goldberg, an economist at TD Securities in New York.