Underlying U.S. inflation increased more than expected in February as rents and medical costs maintained their upward trend, which could keep the Federal Reserve on course to gradually raise interest rates this year.

Other data on Wednesday showed the housing market continuing to strengthen last month, with groundbreaking activity hitting its highest level in five months after being held back by adverse weather.

While the Fed is expected stand pat at the end of Wednesday's two-day policy meeting, stirring inflation, a steady housing sector and tightening labor market conditions have raised the probability of a rate hike in June.

"While few expect the Fed to announce a policy rate hike today, further evidence of building inflationary pressures will reinforce the case for further hikes in the coming months," said Jim Baird, chief investment officer at Plante Moran Financial Advisors in Kalamazoo, Michigan.

The Labor Department said its Consumer Price Index, excluding the volatile food and energy components, increased 0.3 percent last month after a similar gain in January.

In the 12 months through February, the so-called core CPI rose 2.3 percent, the largest gain since May 2012, after increasing 2.2 percent in January. Economists polled by Reuters had forecast the core CPI rising 0.2 percent last month and increasing 2.2 percent from a year ago.

The Fed has a 2 percent inflation target and monitors a price measure, which is also pushing higher. The U.S. central bank raised its benchmark overnight interest rate in December for the first time in nearly a decade.

The dollar rose to a session high against a basket of currencies, while prices for U.S. Treasury debt fell. U.S. stock index futures were marginally lower.



In a separate report, the Commerce Department said housing starts increased 5.2 percent to a seasonally adjusted annual pace of 1.18 million units last month, the highest level since September.

The rebound in groundbreaking activity could lift first-quarter gross domestic product growth estimates, which were cut on Tuesday following February's weak retail sales report. The housing sector is being supported by a firming labor market, which is encouraging young adults to leave their parents' homes.

But builders cannot keep up with the demand for housing because of a shortage of lots and skilled labor, which is driving rents higher in major metropolitan areas.

In February, the core CPI was boosted by a 0.3 percent increase in rents, which followed a similar gain in January.

Medical care costs rose 0.5 percent after advancing by the same margin in January. Prescription drug prices rose 0.9 percent, while the cost of hospital services increased 0.5 percent. There were also increases in apparel prices, which rose 1.6 percent, the largest gain since February 2009.

The second straight month of increase in apparel prices is rather surprising given that retailers are offering big discounts to clear unwanted merchandise from their warehouses.

Prices for new motor vehicles and used cars and trucks also rose last month. But a 13 percent drop in gasoline prices, which offset both the increase in core CPI and a 0.2 percent gain in food prices, lead to the overall CPI falling 0.2 percent in February. The CPI was unchanged in January.

Last month's drop resulted in the CPI increasing 1.0 percent in the 12 months through February, slowing after a 1.4 percent rise in January. 

By Lucia Mutikani - Reuters (Editing by Andrea Ricci)