* Fed now seen delivering 50 bps hike in September
* U.S. consumer price growth slows in July
* Musk sells Tesla shares worth $6.9 bln
* Volatility index closes at four-month low (Adds VIX closes at four-month low, details on S&P 500 surge)
By Herbert Lash and Bansari Mayur Kamdar
NEW YORK, Aug 10 (Reuters) - The Nasdaq and S&P 500 surged more than 2% on Wednesday after data showed U.S. inflation slowed more than expected in July and raised hopes the Federal Reserve will become less aggressive on interest rates hikes.
A sharp drop in the cost of gasoline helped the U.S. Consumer Price Index stay flat last month after advancing 1.3% in June, the Labor Department said. The CPI rose by a less-than-expected 8.5% over the past 12 months after a 9.1% rise in June.
The data was the first notable sign of relief for Americans who have watched inflation steadily climb the past two years.
Fed funds futures traders are now pricing in only a 43.5% chance that the U.S. central bank hikes rates by 75 basis points when it meets in September, compared with 68% before the data. A 50 basis point hike is seen as a 56.5% probability.
"For the market, it's sort of a Goldilocks scenario right now because you have the labor market holding up and inflation potentially starting to come down. That is what a soft landing would look like," said Shawn Snyder, head of investment strategy at Citi U.S. Wealth Management in New York.
But one month of slowing inflation is not enough for the Fed to send an all-clear signal, Snyder said.
The rally on Wall Street was broad-based, with all 11 S&P 500 sectors rising in a sea of green. Growth stocks rose more than value, while Dow transports, small caps and semiconductors also rose.
The Dow Jones Industrial Average rose 535.1 points, or 1.63%, to 33,309.51, while the S&P 500 gained 87.77 points, or 2.13%, to 4,210.24 and the Nasdaq Composite added 360.88 points, or 2.89%, to 12,854.81.
It was the biggest single-day gain for both the Nasdaq and S&P 500 in two weeks, and for the Dow in three weeks. It was the highest close for the S&P 500 since early May.
"(Inflation at) 8.5% is still very high, but there is optimism that perhaps June was the peak," said Randy Frederick, vice president of trading and derivatives for Charles Schwab.
Producer prices data for July on Thursday along with August inflation and employment data for release next month could alter the course of the Fed again, Frederick said.
The Fed has hiked its policy rate by 225 basis points since March despite fears the sharp rise in borrowing costs could tip the U.S. economy into a recession.
The slowing of inflation was the first "positive" reading on price pressures since the Fed began tightening policy, Chicago Fed President Charles Evans said, even as he signaled he believes the Fed has plenty more work to do.
After a rough start to the year, the benchmark S&P 500 is up nearly 15% from mid-June lows, largely on expectations the Fed will be less hawkish than anticipated in its efforts to provide a soft landing for the economy as it fights to curb inflation.
But the S&P 500 remains in a bear market and must climb more than 12% past its all-time high in January to begin a new bull market.
The CBOE Volatility index, Wall Street's fear gauge, fell below the 20.00 level to close at more than a four-month low.
High-growth and megacap technology stocks, whose valuations are vulnerable to rising bond yields, rose as Treasury yields fell sharply across the board. Apple Inc, Alphabet Inc , Amazon.com Inc and Microsoft Corp all rose more than 2% each.
Economy-sensitive banks advanced 2.7%, with Goldman Sachs Group Inc and Morgan Stanley climbing about 3% each.
"Banks have underperformed and are now getting bid," said Thomas Hayes, managing member of Great Hill Capital LLC, adding that investors are chasing the laggards that have not participated in the rally since June lows.
Tesla Inc rose 3.9% after Elon Musk sold $6.9 billion worth of shares in the electric vehicle maker to finance a potential deal for Twitter Inc if he loses a legal battle with the social media platform. Twitter gained 3.7%.
Meta Platforms Inc jumped 5.8% after the Facebook parent said on Tuesday it had raised $10 billion in its first-ever bond offering.
Volume on U.S. exchanges was 11.33 billion shares, compared with the 10.98 billion average for the full session over the past 20 trading days.
Advancing issues outnumbered declining ones on the NYSE by a 5.69-to-1 ratio; on Nasdaq, a 3.34-to-1 ratio favored advancers.
The S&P 500 posted five new 52-week highs and 29 new lows; the Nasdaq Composite recorded 64 new highs and 54 new lows.
(Reporting by Herbert Lash; Additional reporting by Bansari Mayur Kamdar, Aniruddha Ghosh, Sruthi Shankar, Medha Singh and Karina D'Souza in Bengaluru; Editing by Anil D'Silva, Shounak Dasgupta and Lisa Shumaker)