Weak profit margins dampen U.S. producer inflation

(Adds details, analyst comment, background, updates markets)

* Producer prices fall 0.5 percent in February

* Trade services decline by a record 1.5 percent

* PPI excluding food, energy and trade services unchanged

* Consumer sentiment falls in early March on bad weather

By Lucia Mutikani

WASHINGTON, March 13 (Reuters) - U.S. producer prices fell in February for a fourth straight month, pointing to tame inflation that could argue against an anticipated June interest rate hike from the Federal Reserve.

The Labor Department said on Friday its producer price index for final demand declined 0.5 percent as profit margins in the services sector, especially gasoline stations, were squeezed, and transportation and warehousing costs fell.

"The underlying message appears to be that pipeline inflationary pressures remain quite weak, even as energy prices have stabilized and gasoline prices have drifted modestly higher," said Millan Mulraine, deputy chief economist at TD Securities in New York.

The PPI had dropped 0.8 percent in January. In the 12 months through February, producer prices fell 0.6 percent, the first decline since the series was revamped in 2009.

Economists had forecast the PPI rising 0.3 percent last month and remaining unchanged from a year ago.

Prices for U.S. government debt gained marginally on the inflation data. U.S. stock indexes fell sharply, as a strong dollar threatened to erode the profits of multinational companies and tumbling crude prices pressured energy firms including Chevron Corp and Noble Corp.

While the weak inflation backdrop would normally be associated with a struggling economy, there appears to be little reason to worry given the fairly robust labor market.

"We would not take the producer prices report as a sign that the economy is secretly rotten if you pull back the tarp and take a look at the hull. The economy is creating millions of jobs," said Chris Rupkey, chief financial economist at MUFG Union Bank in New York.

A separate report from the University of Michigan showed its consumer sentiment index fell 4.2 points to 91.2 in early March. Lower-income and middle-income households said harsh winter weather had left them with high utility bills and disrupted shopping and general business activity.

Bad weather and a now-settled labor dispute at ports on the West Coast undercut economic activity early in the year.

First (Other OTC: FSTC - news) -quarter GDP growth estimates range as low as a 1.2 percent annual rate and as high as a 2.2 percent rate. The economy expanded at a 2.2 percent rate in the fourth quarter.

JUNE HIKE STILL IN PLAY

The inflation data came ahead of next week's Fed meeting, where policymakers are widely expected to signal the U.S. central bank's openness to a June rate hike by dropping a pledge to be "patient" in considering such a move because of labor market strength.

With price pressures remaining muted and retail sales extending their decline in February, the Fed could delay the move until September.

"The Fed is probably going to hike even if inflation stays low, whether it's June or September, because they are confident about the strong labor market conditions ultimately leading to higher inflation," said Michelle Girard, chief economist at RBS (LSE: RBS.L - news) in Stamford, Connecticut.

The Fed, which has a 2 percent inflation target, has kept its key short-term interest rate near zero since December 2008.

Services accounted for 70 percent of the decline in the PPI last month. The volatile trade services component, which mostly reflects profit margins at retailers and wholesaler, fell a record 1.5 percent in February.

It was pulled down by a 13.4 percent drop in margins at gasoline service stations, reflecting a recent plunge in prices at the pump. Profit margins also fell for apparel, footwear and jewelry retailers, as well as for food and alcohol.

There also were declines in machinery, equipment, parts and supplies wholesale margins, signs that a strong dollar - it has appreciated more than 17 percent since July on a trade-weighted basis - was helping to keep a lid on inflation.

A 1.5 percent drop in transportation and warehousing services also weighed on producer prices last month. Energy prices, which had been a drag on producer inflation in recent months, were unchanged in February.

A key measure of underlying producer price pressures that excludes food, energy and trade services was unchanged after a record 0.3 percent drop in January.

"It suggests that the stronger dollar and second-round effects from the decline in energy are still suppressing pipeline inflation," said Blerina Uruci, an economist at Barclays (LSE: BARC.L - news) in New York. (Reporting by Lucia Mutikani; Additional reporting by Sam Forgione in New York; Editing by Paul Simao)