Economic data suggests soft patch continues

WASHINGTON (Reuters) - U.S. factory output slipped for the first time in 10 months in April as a shortage of parts from Japan crimped activity and home building slumped, showing the economy got off to a weak start in the second quarter.

Signs of lackluster economic activity were also evident in declines in sales at Wal-Mart Stores, which said its customers were still living from paycheck to paycheck. Home Depot also reported a drop in sales while Hewlett-Packard cut its 2011 profit forecast.

Despite the weak data, analysts are still cautiously optimistic the economy will regain speed this quarter after growth slowed to a 1.8 percent annual pace in the January-March period.

"It's a sluggish start," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "Since the beginning of this year the recovery seems to have hit a bit of a soft patch, but conditions should improve for the remainder of this year."

Manufacturing output fell 0.4 percent, breaking nine straight months of gains, as supply disruptions from Japan's earthquake hit auto production, the Federal Reserve said.

Overall industrial production was flat, with gains in mining and utilities offsetting the drop in factory output. Excluding cars and parts, manufacturing output rose a sluggish 0.2 percent.

A separate report from the Commerce Department showed groundbreaking for new housing dropped 10.6 percent to an annual rate of 523,000 units as a glut of homes on the market discouraged new projects.

Though March's housing starts were revised up substantially, it was not enough to soften the blow from last month's drop.

"The recovery in the housing sector is still wanting and is still a hope more than a reality," said Anthony Chan, chief economist at JPMorgan Private Wealth Management in New York.

Economists, who had expected starts to rise to a 568,000-unit rate, said tornadoes that lashed parts of the country last month were partly to blame for the drop. Starts in the tornado-ravaged South slumped to a two-year low.

Hopes are high that gasoline prices will fall and the nascent labor market recovery will strengthen enough to boost consumer spending and therefore economic growth.

PAYCHECK CYCLE STILL IN EFFECT

Wal-Mart said U.S. sales fell in the February to April quarter, adding it continued to see a paycheck cycle, where people stock up around payday and then spend less as money runs out.

U.S. stocks fell on concerns about the economic recovery, while Treasury debt prices rose. The dollar was flat against a basket of currencies.

Manufacturing has been leading the recovery and economists expect it to bounce back as auto supply disruptions fade.

Housing, however, is a different matter. Construction is being crowded out by an oversupply of homes and in particular foreclosed properties that sell well below their value.

In March, the spread between the prices of new and previously owned houses was about $54,200, indicating used homes are selling well below the cost of construction. A spread of between $20,000 and $30,000 is generally viewed as ideal.

A report on Monday showed that while builders expected a modest improvement in sales during spring, they anticipate market conditions to weaken in the next six months.

Analysts estimate there are between eight and nine million homes on the market, including the so-called shadow inventory -- foreclosed properties and those which are about to be repossessed by banks.

"The shadow housing inventory is coming to the market and is hindering the need to really start building more houses," said Chan.

The weight on the economy will be limited, however, since residential construction only accounts for about 2.2 percent of gross domestic product.

In addition, with the labor market showing signs of life, analysts are guardedly optimistic of a slight improvement as the year progresses. A similar outlook was shared by Home Depot, which raised its profit forecast for the year despite a slow start to the spring selling season.

Groundbreaking last month was depressed by a 24.1 percent tumble in the volatile multi-family homes sector, where starts for buildings with five or more units dropped 28.3 percent. Single-family home construction fell 5.1 percent.

Permits for future home construction dropped 4.0 percent to a 551,000-unit pace last month. They were held down by an 8.8 percent drop in the multi-family segment. Permits to build single-family homes slipped 1.8 percent.

(Additional reporting by Mark Felsenthal; Editing by James Dalgleish)