* Consumer price index flat in July
* CPI increases 0.8 percent from year ago
* Core CPI rises 0.1 percent; up 2.2 percent from year ago
* Housing starts climb 2.1 percent; permits dip 0.1 percent
* Industrial production rises 0.7 percent

US consumer prices were unchanged in July on falling gasoline costs, but solid gains in industrial output and home building suggested a pickup in economic activity that could allow the Federal Reserve to raise interest rates this year.

Tuesday's mixed reports came as influential New York Fed President William Dudley said the US central bank could hike rates next month, citing a tightening labour market that he said was starting to spur faster wage growth.

‘The strong housing starts and industrial output performance will bolster the Fed confidence that growth momentum has rebounded, potentially supporting the bias for a near-term hike,’ said Millan Mulraine, deputy chief economist at TD Securities in New York. ‘Nevertheless, with inflation continuing to miss to the downside, the case for caution remains strong.’

July's flat reading in the Consumer Price Index was the weakest since February and followed two straight monthly increases of 0.2 percent. In the 12 months through July, the CPI rose 0.8 percent after increasing 1.0 percent in June.

The so-called core CPI, which strips out the volatile food and energy components, edged up 0.1 percent in July. It had risen by 0.2 percent in each of the previous three months. The year-on-year core CPI increased 2.2 percent in July after advancing 2.3 percent in June.

The Fed has a 2 percent inflation target and tracks an inflation measure which has been stuck at 1.6 percent since March. ‘It's possible’ for the Fed to hike rates at its Sept. 20-21 policy meeting, Dudley told Fox Business Network.

In the wake of Dudley's remarks, financial markets were placing a 51.4 percent probability of a rate increase at the Fed's December policy meeting, up from 46.7 percent late on Monday, according to CME Group's FedWatch tool. A September rate hike has been virtually priced out.

The inflation data, however, pushed the dollar lower against a basket of currencies. US stocks and Treasuries fell on Dudley's comments. The Fed raised its benchmark overnight interest rate in December for the first time in nearly a decade.

But with rents and healthcare costs continuing to rise, some economists do not expect July's moderation in underlying inflation to be sustained. Medical care costs climbed 0.5 percent last month, adding to June's 0.2 percent gain.

INDUSTRIAL OUTPUT JUMPS

There were also increases in the costs of hospital services, doctor visits and prescription medicine. Rents increased a solid 0.3 percent. But Americans got some relief from gasoline prices, which dropped 4.7 percent last month, the first decline since February, reflecting renewed declines in crude oil prices.

The cost of food consumed at home fell for a third straight month, with prices for meat, eggs, dairy and cereals declining. Prices for new motor vehicles rose for the first time since February, while the cost of apparel was unchanged.

Despite benign inflation, economic growth is picking up after output averaged 1.0 percent in the first half of the year. In a separate report, the Fed said industrial production shot up 0.7 percent last month after rising 0.4 percent in June.

Production was boosted by a 0.5 percent jump in manufacturing output, the largest gain since July 2015. Warmer-than-usual weather boosted utilities production by 2.1 percent while mining output increased 0.7 percent.

‘Overall, these factors suggest the outlook for the US industrial sector has improved modestly and support our expectation of healthier economic growth in the second half of 2016,’ said Jesse Hurwitz, an economist at Barclays in New York.

In a third report, the Commerce Department said housing starts increased 2.1 percent to a seasonally adjusted annual pace of 1.2 million units in July, the highest level since February.

Last month's increase in groundbreaking activity supports the view that investment in residential construction will rebound after slumping in the second quarter for the first time in more than two years.

With the housing market on solid ground, home improvement retailers are also getting a boost. Home Depot Inc on Tuesday raised its full-year earnings forecast after reporting a 6.6 percent rise in quarterly sales.

Groundbreaking on single-family homes, the largest segment of the market, rose 0.5 percent to a 770,000-unit pace in July, also the highest level since February.

Housing starts for the volatile multi-family segment increased 5.0 percent to a 441,000-unit pace. Groundbreaking on multi-family housing projects with five units or more jumped to the highest level since September 2015.

The multi-family segment of the market continues to be supported by strong demand for rental accommodation as some Americans shun homeownership in the aftermath of the housing market collapse.