By Mark Felsenthal
WASHINGTON (Reuters) - U.S. industrial output posted its biggest drop since 1974 in September, while a regional factory index slumped this month and labor markets showed softness, suggesting the economy has fallen into recession.
The series of grim reports on Thursday made clear that even if unprecedented government measures to stabilize financial institutions succeed in restoring lending, the underlying economy has been seriously damaged from months of turmoil.
"The data suggests the U.S. economy is mired in recession and things are getting worse rather than better," said Sal Guatieri, an economist for BMO Capital Markets in Toronto.
At the same time, consumer prices held steady last month as energy prices slipped, which could give the U.S. Federal Reserve room to cut interest rates further to lift to an economy that could be facing a protracted slump.
The data pressured stocks in early trade, but shares posted a late rally and the blue chip Dow Jones industrial average <.DJI> closed up 401 points, or 4.7 percent. On Wednesday, the Dow had suffered its worst day since the 1987 crash.
Production at the nation's factories, mines and refineries tumbled 2.8 percent last month, the Federal Reserve said, far worse than economists had expected. Business equipment production dropped 7 percent, a sign companies were retrenching as the credit crisis intensified.
The Fed said Hurricanes Gustav and Ike, as well as a strike at aircraft maker Boeing
"Over the last three months, production is down 5.8 percent and is consistent with a recession," John Silvia, chief economist at Wachovia Corp, said in a note to clients.
In a further indication of the impact of the credit crunch on the broader economy, a private-sector poll of home builder confidence fell to a record low in October.
A separate survey on factory activity in the Mid-Atlantic region in October also suggested the economy was braking sharply. The Philadelphia Federal Reserve Bank said its business activity index slumped to its lowest level since October 1990.
BRACING FOR TOUGH TIMES
Manufacturing giants United Technologies Corp
"We know 2009 is going to be the toughest year we've seen for some time," said Greg Hayes, chief financial officer at United Technologies.
Data on claims for jobless benefits were mixed, but still indicated a soft labor market.
The Labor Department said first-time claims for state unemployment insurance fell 16,000 last week. However, a federal holiday may have skewed the data and a four-week moving average that smooths weekly volatility hit its highest since October 2001, just after the September 11 attacks.
The number of people remaining on the benefits rolls after drawing an initial week of aid in week ended October 4 rose 40,000 to 3.71 million, the highest since June 2003.
"With companies cutting back ... the outlook for payrolls and the unemployment rate is terrible," said Ian Shepherdson, chief economist for High Frequency Economics in Valhalla, New York. "Even with the banking crisis easing, the Fed will be under pressure from the ... data to keep cutting rates."
The U.S. central bank cut benchmark borrowing costs by a half-percentage point to 1.5 percent last week, citing an intensification of financial turbulence, and is expected to reduce rates further at a meeting on October 28-29.
Economists said the benign reading on inflation should ease the minds of some policy-makers who had been concerned about fast-rising prices.
After a steep run-up that had pushed the inflation rate to an 17-1/2 year high, energy costs have come down sharply. Outside of the volatile food and energy areas, consumer prices posted a tame 0.1 percent gain.
(Additional reporting by Scott Malone in Boston, Emily Kaiser in Washington, and Lynn Adler, Burton Frierson and John Parry in New York, Editing by Chizu Nomiyama)
