Core consumer inflation rose at quickest pace in nearly three years in May and a regional manufacturing gauge contracted this month, underscoring the headwinds facing the economy.

The Labor Department said on Wednesday its Consumer Price Index, excluding food and energy, increased 0.3 percent, the largest gain since July 2008, after rising 0.2 in April.

Core inflation was lifted by steep rises in motor vehicle and apparel prices and economists had expected the measure, which is closely watched by the Federal Reserve, to rise 0.2 percent last month.

The year-over-year core inflation index rose 1.5 percent in May from 1.3 percent in April.

Overall CPI increased 0.2 percent, slowing from a 0.4 percent advance in April, as gasoline prices fell. That compared to expectations for a 0.1 percent gain.

But in the 12 months to May, consumer prices rose 3.6 percent, the biggest jump since October 2008, and well above expectations for a 3.4 percent increase.

Separately, the New York Fed's Empire State general business conditions index fell to -7.79 from, contracting for the first since November, from 11.88 in May, surprising economists who had expected a rise to 12.50.

I assume people will look at this as another reason the recovery is stalling, giving more fodder to the double dip theory, said Paul Radeke, vice president at KDV Wealth Management in Minneapolis.

However, other data has shown that the consumer remains on track, suggesting that eventually manufacturing will catch up. However, this data suggests that process will take longer.

The data puts the Fed in a difficult position since the rising underlying inflation would make it more difficult to argue for further monetary stimulus even if the economy weakens substantially.

The U.S. central bank concludes a $600 billion government bond-buying plan at the end of the month. Policy makers, who have faced intense criticism for risking inflation, have set the bar very high for any new program to aid the fragile economy.

GASOLINE PRICES FALL

Gasoline prices fell 0.2 percent last month after increasing 3.3 percent in April. Gasoline prices have dropped to about 25 cents to $3.78 a gallon from early May.

Food prices rose 0.4 percent after increasing by the same margin in April.

The core reading, which is closely watched by the U.S. central bank as a guide to monetary policy, was boosted by rising prices for housing, new vehicles, used trucks and medical care.

Shelter costs, which account for about 40 percent of core CPI, 0.2 percent, rising by 0.1 percent in April.

Prices for new vehicles rose 1.1 percent last month -- the largest increase since October 2009, likely reflecting lean supplies as a shortage of parts in the wake of the devastating earthquake and tsunami in Japan disrupts production.

They increased by 0.7 percent in April. Apparel prices rose 1.2 percent, the biggest advance since February 2009, after gaining 0.2 percent in April.

In the 12 months to May, core CPI 1.5 percent - the largest increase since January 2010, after increasing 1.3 percent in April. Fed officials, however, would like to see that closer to 2 percent.

(Reporting by Lucia Mutikani)

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