The barrage of positive economic news from United States released Tuesday has traders worrying the Federal Reserve Board may not cut interest rates as aggressively as expected.

The big news was that the U.S. consumer price index beat expectations in May. While the headline rate was unchanged, the core rate jumped 0.3%, stinging those who expected the threat of deflation to spark another round of U.S. rate cutting.

BMO Nesbitt Burns attributes the rise to, “A very large jump in lodging away from home, along with a rise in public transportation that was largely attributed to a NYC subway fare hike.” It comments, “This put a little zig in the recent dive in the core inflation rate, nudging it up to 1.6%.”

CIBC World Markets says that the numbers should calm deflation fears. “We had been looking for a tamer 0.1% core rise, so the 0.3% increase runs a bit counter to our call for a few months of negative readings on total CPI early next year. But the narrow basis of the upward surprise, and the tame 3-month rate, suggests that core prices are still in a disinflationary trend,” it says. “Energy prices have also temporarily stalled out in the post-war march to more temperate readings, although we still see both crude and natural gas prices as heading for significantly negative year-on-year readings by early 2004.”

In a separate announcement, the Federal Reserve Board reported U.S. industrial production rose 0.1% in May. RBC Financial says that this was above expectations of a flat reading. “Closely-watched business equipment production was flat in May after sizable falls in March and April, suggesting continued stagnation in business capital spending,” it says, noting that capacity utilization was flat in May at 74.3%. “Capacity utilization remains at a 20-year low, seven percentage points below the longer-term average and nearly ten below the cyclical peak three years ago. The factory sector has likely bottomed out but cannot be counted upon to be a source of growth just yet,” RBC concludes.

Nesbitt says that the industrial production numbers show modestly more improvement in the U.S. than expected. “Nonetheless, the situation remains fragile and the focus will remain on upcoming regional purchasing managers’ indexes and the June ISM figures due out in two weeks,” it says. “It is hoped that the weak greenback and firming demand will help restore production to a rising trend.”

U.S. housing starts for May were also released Tuesday. They showed an increase to an annualized 1.732 million units from 1.63 million units in April, also above expectations. Residential building permits rose 3.7%.

CIBC says that with all the news, markets are now pricing in better odds of a quarter point Fed move rather than a 50 bps cut. “We think that the Fed will in fact be guided somewhat in its choice by what’s priced into the curve, since it doesn’t want to disappoint on the day of the announcement. So odds at this point still lean, if only slightly, in favor of a quarter point reduction, with a further quarter point “saved” for the subsequent FOMC meeting.”

Nesbitt says that the fixed-income market is priced for perfection and participants will likely get cold feet about a 50 basis point easing move at the June 25 FOMC meeting. “If so, we would suggest that any sell-off represents a new opportunity to bet on that outcome. The Fed feels that it should be well ahead of the curve on this issue – recall the Chairman’s recent remark about needing a “firebreak” against deflation.”

It allows that the May CPI figures did not give the Fed additional reason to fear deflation is looming. “However, a close look at the numbers suggests that one-off large price hikes are the story and that conclusive evidence that the deflationary threat is diminishing cannot be drawn from this result,” Nesbitt says.

RBC continues to expect a 25 basis point cut, with a prolonged period of steady low rates thereafter. “Indicators remain volatile and the U.S. economy is not out of the woods yet,” it says.