(Updates after U.S. stock market close)
* Wall Street rallies with Nasdaq leading gains
* CPI was flat in July after rising 1.3% in June
* In 12 months through July, CPI rose 8.5% vs 9.1% in June
By Sinéad Carew
NEW YORK, Aug 10 (Reuters) - Wall Street equities rallied and the dollar tumbled after signs of sharply decelerating U.S. inflation prompted bets that the Federal Reserve would raise interest rates at a slower pace than previously expected.
Treasury yields mostly pulled back from an earlier plunge as investors digested data showing that consumer prices did not rise in July as the cost of gasoline fell, delivering the first notable sign of relief for Americans who have watched inflation soar over the past two years.
Traders priced in a 50 basis points rate hike next month, compared with the 75 bps increase that had been expected before inflation report.
"This morning's inflation report was a stress reliever and now we're getting buying in stocks, bonds and commodities. We haven't had an inflation release that was lower than expected in quite some time," said John Augustine, chief investment officer at Huntington National Bank in Columbus, Ohio.
But Augustine said that there was still a lot of uncertainty around what the Fed will do and the economic growth and earnings outlook for 2023. "We're staying neutral here until we get a better view of next year," he said.
The Dow Jones Industrial Average ended the session up 535.1 points, or 1.63%, at 33,309.51 while the S&P 500 rose 87.77 points, or 2.13%, to 4,210.24 and the Nasdaq Composite added 360.88 points, or 2.89%, to finish at 12,854.81.
The Nasdaq closed 20.8% above its recent closing low reached on June 16. It would have to rise an additional 24.9% from Wednesday's close to return to its record high, reached in November, to confirm a new bull market.
The pan-European STOXX 600 index closed up 0.89% and MSCI's gauge of stocks across the globe gained 1.80%.
In Treasuries, benchmark 10-year notes last rose 2/32 in price to yield 2.7901%, from 2.797% late on Tuesday. The 30-year bond last fell 19/32 in price to yield 3.0359%, from 3.005%.
The 2-year note last rose 4/32 in price to yield 3.2244%, from 3.286%. The drop in Treasury yields immediately after the inflation data indicated that traders had been expecting a rise in inflation.
During Wednesday's session, Chicago Fed President Charles Evans said inflation was still "unacceptably" high, and that the Fed would need to continue to raise rates.
Minneapolis Federal Reserve Bank President Neel Kashkari said that while the inflation reading was "welcome" the Fed was "far, far away from declaring victory" and needed to raise rates much higher.
The dollar index fell 1.072%, with the euro up 0.87% to $1.03.
The Japanese yen strengthened 1.69% versus the greenback at 132.91 per dollar, while sterling was last trading at $1.2217, up 1.13% on the day.
Oil prices rebounded from losses early in the session after encouraging figures on U.S. gasoline demand and as lower-than-expected U.S. inflation data drove investors into riskier assets.
U.S. crude settled up 1.58% at $91.93 per barrel and Brent finished at $97.40, up 1.13% for the day.
Spot gold dropped 0.2% to $1,790.80 an ounce as hawkish remarks from U.S. Federal Reserve officials dampened hopes of a let-up in aggressive policy tightening after the inflation data. Gold had charged higher and broke above the $1,800 level before losing ground.
(Reporting by Sinéad Carew, Karen Brettell, Lawrence White and Sam Byford; Additional reporting by Sujata Rao; Editing by Kirsten Donovan, John Stonestreet and Deepa Babington)