(Corrects to 'pursuit,' not 'dispute' in paragraph 5)
* Dollar rallies after inflation's upward surprise
* Global stock index in the red, Wall Street stocks sell off
* Oil prices lose ground, Treasury yields rise
By Sinéad Carew
NEW YORK, Sept 13 (Reuters) - The dollar index reversed course on Tuesday to rally sharply and U.S. stocks sank while Treasury yields climbed after data showed U.S. consumer prices rising faster than expected in August, prompting bets for more aggressive Federal Reserve rate hikes.
Oil futures turned red after the Labor Department data on Tuesday showed that declining gasoline prices in August were offset by gains in rent and food costs. The Consumer Price Index gained 0.1% last month versus expectations for a 0.1% decline and after being unchanged in July.
U.S. stock indexes had rallied on Monday after also gaining ground the week before as investors had bet Tuesday's data would show some dampening in inflation and provide a path for the Fed to ease its policy tightening.
"Moderating inflation is key to higher equity prices and at the moment inflation is running hot. That implies volatility will remain more the norm than the exception into year-end." said Terry Sandven chief equity strategist at US Bank Wealth Management in Minneapolis.
"It clearly suggests the Fed next week will deliver more of the same and remain unwavering in their pursuit to tame inflation."
The Dow Jones Industrial Average fell 967.37 points, or 2.99%, to 31,413.97, the S&P 500 lost 135.93 points, or 3.31%, to 3,974.48 and the Nasdaq Composite dropped 510.05 points, or 4.16%, to 11,756.36.
"With the rally over the last week and yesterday, the market's risk reward coming into this report was a little skewed to the downside anyway even if we did get a report that was in-line or slightly below expectations. This report was a negative surprise with hotter inflation," said Mona Mahajan, senior investment strategist at Edward Jones.
"This was another disappointment. It's the old Charlie Brown analogy. Every time we're ready to kick the ball it's moved away from us."
The pan-European STOXX 600 index closed down 1.55% while MSCI's gauge of stocks across the globe was down 2.69%.
In currencies, the dollar index rose 1.377%, with the euro down 1.32% to $0.9985.
The Japanese yen weakened 1.03% versus the greenback at 144.31 per dollar, while Sterling was last trading at $1.1517, down 1.39% on the day.
"This is going to put the idea of transitory inflation to bed for now and anchor U.S. yields and the dollar substantially higher. The key thing here is that we're now looking at near-certain odds on a 75-basis-point move next week," said Karl Schamotta, chief market strategist at Corpay in Toronto.
Meanwhile, U.S. Treasury yields surged and a recession warning - the yield curve inversion - widened after the inflation data also bucked bond investor expectations implying that the Fed will crack down further on inflation.
Benchmark 10-year notes last fell 18/32 in price to yield 3.4293%, from 3.362% late on Friday. The 30-year bond last fell 1/32 in price to yield 3.5139%, from 3.513%. The 2-year note last fell 12/32 in price to yield 3.7643%, from 3.571%.
The gap between yields on two- and 10-year notes , seen as a recession harbinger, was at -33.9 basis points.
Oil prices reversed earlier gains to swing lower on Tuesday after the inflation data implied more hefty rate hikes from the Fed and renewed COVID-19 curbs China, the world's second-largest oil consumer, also weighed on crude prices.
Oil is generally priced in U.S. dollars, so a stronger greenback makes the commodity more expensive to holders of other currencies.
U.S. crude settled down 0.54% to $87.31 per barrel and Brent was at $93.38, down 0.66% on the day.
The climbing dollar also put pressure on gold prices. Spot gold dropped 1.1% to $1,704.47 an ounce. U.S. gold futures fell 1.45% to $1,705.00 an ounce.
(Additional reporting by Caroline Valetkevitch in New York, Marc Jones in London, Yoruk Bahceli in Amsterdam; Editing by Louise Heavens and Nick Zieminski)