Consumer prices fell for the first time in a year last month and the closely watched core inflation rate posted its smallest annual gain since 1966, pointing to a lack of price pressure as the economic recovery gathers steam.

The Consumer Price Index unexpectedly slipped 0.1 percent in April, the Labor Department said on Wednesday, which analysts said should allow the U.S. Federal Reserve to focus on supporting growth, especially as Europe's debt crisis looks set to slow economies in that region.

An industry report released separately showed demand for loans to buy homes sank 27.1 percent to a 13-year low last week after the expiry of a home buyers tax credit, suggesting a recovery in housing will be painfully slow.

The inflation picture is very well controlled and that's going to give the Fed an opportunity to stay accommodative for a longer period of time. It's a good environment to help keep the economy here growing, said Michael Strauss, chief economist at Commonfund in Wilton, Connecticut.

The April CPI was pulled down by declining energy costs. Consumer prices rose 0.1 percent in March and analysts had expected a similar gain in April.

The core inflation rate, which excludes volatile food and energy costs, was flat last month. Over the past 12 months, core inflation has risen just 0.9 percent, the smallest gain in more than 44 years.

The Fed cut benchmark overnight lending rates to near zero in December 2008 and has vowed to keep them extraordinarily low for an extended period to nurse the economy back from its worst downturn since the 1930s.

Minutes of the Fed's April policy meeting, released on Wednesday, indicated the U.S. central bank does not see inflation as a near-term risk.

While the economy has grown for three straight quarters and employers have added jobs for four months in a row, the unemployment rate stands at 9.9 percent.

STUBBORNLY HIGH UNEMPLOYMENT

Analysts said with unemployment still stubbornly high, inflation was likely to remain muted for a while, and some even saw the risk of deflation -- an economically disabling, broad-based decline in consumer prices.

Elevated unemployment and stagnant wages have caused retail chains to slash prices and firms have chosen to absorb increasing costs at earlier stages of production rather than pass them along downstream, said Joseph Brusuelas, chief economist at Brusuelas Analytics in Stamford, Connecticut.

U.S. financial markets shrugged off the data, remaining preoccupied with Europe's debt troubles. The broad U.S. Standard & Poor's index <.SPX> briefly pierced 1,102.12, its 200-day moving average, seen as a support level. It pulled back to end down 0.51 percent at 1,115.05.

Speculation European monetary authorities might act to support the euro saw the U.S. climb down from a four-year high against the single euro zone currency. Prices for U.S. government bonds fell modestly.

While analysts generally believe the fiscal problems in Europe will have a minimal impact on the U.S. economy, Paul Volcker, the former Fed Chairman who is a White House economics adviser, said the European crisis showed the risks for the nation if it did not get its budget deficit under control.

The U.S. government's record economic stimulus package helped push the budget deficit last year to $1.4 trillion, roughly 10 percent of gross domestic product. There have been fears the budget deficit and the vast amounts of money pumped into the economy by the Fed could stoke inflation.

For now, those concerns have faded as substantial slack in the economy is keeping price pressures subdued.

Contributing to the consumer price weakness in April, energy and gasoline costs saw their largest declines in over a year. Food prices rose moderately for a second straight month.

Core consumer prices were held back by new vehicle and shelter costs, which were unchanged. Clothing prices fell, while medical care costs rose marginally.

A glut of homes on the market is keeping rental costs in check, a trend likely to continue amid expectations the housing market will struggle to recover without government incentives.

Home buyers looking to cash in on federal tax credits had to have signed contracts by April 30 and must close on their loans by June 30.

The week ended May 14 was the second straight week that demand for loans to buy homes fell, after three straight weeks of sharp gains before the April 30 deadline, data from the Mortgage Bankers Association showed.

It's disturbing, said John Canally, economist at LPL Financial in Boston. It seems that every other data point for housing is pretty good, so I'm leaning toward the hangover from the tax credit.

Demand to refinance mortgages, however, jumped 14.5 percent last week to a nine-week high. But in another sign of problems plaguing the housing recovery, the industry group also said one in every seven households with a mortgage ended the first quarter behind on payments or in foreclosure.

(Additional reporting by Lynn Adler; Editing by Diane Craft)

Inflation