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By Sinéad Carew

NEW YORK (Reuters) – Wall Street equities rallied and Treasury yields plunged after signs of sharply decelerating U.S. inflation prompted bets that the Federal Reserve would raise rates at a slower pace than previously expected.

The dollar also tumbled after U.S. data showed that consumer prices did not rise in July as the cost of gasoline fell, delivering the first notable sign of relief for Americans who have watched inflation soar over the past two years.

Traders are now pricing in a 50 basis points rate hike next month, not the 75 basis point increase that had been expected before the consumer price index report.

But while the data made riskier bets more attractive, some strategists were still cautious.

It’s quite a surprise and that’s why the market is reacting so positively. Is this a solid indication inflation is waning? It’s too early to make that statement. On the other hand assuming this data doesn’t get revised its certainly good news for the economy,” said Tim Ghriskey, senior investment strategist at Ingalls & Snyder in New York.

The Fed will also take into account more inflation readings and August jobs data before deciding on the size of its next rate hike at the September meeting.

There’s still quite a bit of data between now and September…we’ve only gotten one out of two CPI prints before then and we’ve got another payroll print as well and a full set of data effectively for August, so I think the jury’s still very much out on September,” said Gennadiy Goldberg, interest rate strategist at TD Securities in New York.

The Dow Jones Industrial Average rose 494.09 points, or 1.51%, to 33,268.5, the S&P 500 gained 68.45 points, or 1.66%, to 4,190.92 and the Nasdaq Composite added 262.09 points, or 2.1%, to 12,756.02.

The pan-European STOXX 600 index rose 0.71% and MSCI’s gauge of stocks across the globe gained 1.40%.

In Treasuries, Benchmark 10-year notes last rose 21/32 in price to yield 2.7225%, from 2.797% late on Tuesday. The 2-year note last rose 10/32 in price to yield 3.1191%, from 3.286%.

The yield curve between two-year and 10-year notes was at 39 basis points after earlier reaching minus 53 basis points, the deepest inversion since 2000.

The sharp drop in Treasury yields indicates that traders were likely positioned for a larger inflation increase.

The downside miss is certainly not something the markets were positioned for, I think the market was really one way positioned for a higher inflation print and higher Fed pricing,” said TD Securities’ Goldberg.

In currencies, the dollar index fell 1.1%, with the euro up 1.01% to $1.0314.

The Japanese yen strengthened 1.73% versus the greenback to 132.84 per dollar, while sterling was last trading at $1.2214, up 1.11% on the day.

Oil prices fell in volatile trade as Druzhba pipeline flows resumed and as an expected rise in U.S. crude stocks intensified demand concerns.

U.S. crude recently fell 0.92% to $89.67 per barrel and Brent was at $95.40, down 0.94% on the day. [O/R]

Spot gold added 0.2% to $1,796.84 an ounce. It had charged higher and broke above the key $1,800 level right after the inflation data before leveling off.

(Reporting by Sinéad Carew, Karen Brettell, Lawrence White and Sam Byford; Additional reporting by Sujata Rao; Editing by Kirsten Donovan)

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