U.S. retail sales rose solidly in September while a key inflation gauge remained muted, data on Friday showed, suggesting the economy retained some buoyancy despite a weakening housing sector.

With consumers flexing their spending power even despite tightening credit conditions that had prompted the Federal Reserve to lower interest rates last month, many investors concluded the central bank would hold off cutting rates further at its end-of-month meeting.

U.S. stocks rose as concerns about economic growth eased, while prices for government bonds fell and the dollar rose on the dampened rate cut expectations.

People were expecting that perhaps the economy was on the brink of recession, but you can't have a recession if consumers are continuing to spend and by all means they seem to be continuing to spend, said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.

When the Fed lowered interest rates by a half-percentage point on September 18, economic reports looked dour, with a surprisingly weak August employment figure triggering recession fears. But the latest batch of data paints a less gloomy picture of an economy that is slowing, but not stalling.

Inflation fears had picked up after the Fed's interest rate cut last month, but a report from the Labor Department showed that core inflation at the producer level rose a slight 0.1 percent last month, less than economists had forecast. Including volatile food and energy prices, U.S. producer prices advanced by a larger-than-expected 1.1 percent.

CONSUMER IS GOING TO BE OK

Retail sales rose a bigger-than-expected 0.6 percent as sales at gasoline stations showed their strongest growth since May, the Commerce Department said. Car sales also were brisk.

Even excluding cars and gasoline, retail sales were up 0.2 percent. Analysts had expected overall sales to gain just 0.2 percent.

However, there were some concerns that October's sales may look less rosy. Consumer sentiment in the Reuters/University of Michigan Surveys of Consumers dipped to 82.0 in early October, the lowest reading since August 2006 and slightly below analysts' expectations.

The data came one day after major U.S. retail chains reported disappointing September sales, which they blamed on unusually warm weather that curbed demand for fall clothing.

The retail numbers are where the action is at. With all the concerns about the consumer, and the fact a number of retailers suggested weaker sales this week, this is a big number, said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis.

This builds the case that there is not a lot of fallout from the (housing and credit) crisis on consumer spending, Paulsen said. We are really starting to build a case here: jobs are OK, consumer OK and if the consumer is going to be OK, the economy's going to be OK.

With last week's employment report showing solid job gains in both September and August, the Fed may be content to leave interest rates unchanged on October 31.

Corporate America also seemed to be on solid footing, with General Electric Co reporting a 14 percent rise in quarterly profit and McDonald's Corp forecasting earnings above Wall Street's expectations.

Still, there were some signs that businesses were retrenching as they try to measure how severely the housing recession and credit crunch will hurt the economy.

The Commerce Department said U.S. business inventories -- a key component of gross domestic product -- rose a smaller-than-expected 0.1 percent in August, while sales of goods dropped 0.4 percent.

Given the turmoil in the markets that characterized a good portion of the sampling period, it is not surprising that firms choose to pull back on the reins a bit, said Joseph Brusuelas, chief U.S. economist at IDEAglobal in New York.

(Additional reporting by Alister Bull and Nancy Waitz)

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