Industrial output falls, monetary easing seen

WASHINGTON (Reuters) - U.S. industrial output shrank last month for the first time in more than a year, a sign the economy was in a slow growth rut that appears certain to lead to more monetary stimulus from the Federal Reserve.

Another report on Monday showed home-builder sentiment rose this month but remained at depressed levels, fortifying views that the Fed -- the U.S. central bank -- would pump more money into the economy at its next policy meeting on November 2-3.

"The industrial production report illustrates, if anything, economic growth is still slowing rather than beginning to pick up again, which is yet another reason for the Fed to unleash QE2," said Paul Ashworth, a senior U.S. economist at Capital Economics in Toronto, using market shorthand for a second round of quantitative easing to try to stimulate the economy and keep interest rates down by buying more government debt.

Industrial production fell 0.2 percent in September, the first decline since June 2009, the Fed said. Economists had expected industrial production to rise 0.2 percent, the same as in August.

Separately, the National Association of Home Builders/Wells Fargo Housing Market Index rose three points to 16 in October, beating economists' expectations for a 1-point rise to 14.

A reading below 50 indicates that more builders view sales conditions as poor than good. The index has not been above 50 since April 2006.

The recovery from the worst recession in 70 years has slowed markedly, leaving unemployment uncomfortably high and inflation too low for the Fed's liking.

Frustration over the sluggish economy, in particular the 9.6 percent unemployment rate, could deal a blow to the Democratic Party in November 2 congressional elections. Republicans are expected to win control of the U.S. House of Representatives and pick up some Senate seats.

The tepid recovery is also proving problematic to the Fed, which cut overnight interest rates to near zero in December 2008 and has already pumped $1.7 trillion into the economy by buying mortgage-related and government bonds. It now appears on the verge of launching another round of bond buying.

STIMULUS SIZE UNCLEAR

On Friday, Fed Chairman Ben Bernanke offered a strong signal that more monetary policy easing was imminent, but offered few clues on the size of the asset purchase program.

Financial markets, which have largely priced in a second round of quantitative easing, were little moved by the economic data. U.S. stocks ended higher on better-than-expected results from Citigroup , while bargain-hunting after recent losses lifted prices for government debt.

The U.S. dollar fell against a basket of currencies <.DXY>.

In the third quarter, production at the nation's mines, factories and refineries rose at an annual rate of 4.8 percent, slowing from a pace of about 7 percent in the second quarter.

Output in September was pulled down by a 0.2 percent decline in manufacturing production, which analysts said confirmed other recent signs of a slowdown in factory activity as the boost from the rebuilding of inventories fades.

Manufacturing of consumer goods declined for a second straight month.

"It reinforces our belief that inventory accumulation has got a little bit ahead of itself and most likely will have to come down and this is going to weigh on output over the next months," said Aaron Smith, a senior economist at Moody's Economy.com in West Chester, Pennsylvania.

Analysts expected a small boost from inventories to third-quarter economic growth and a minor drag to output for the final three months of the year. They saw no collapse in manufacturing activity, despite the contraction in September.

Mining output rose 0.7 percent last month, while utilities' production dropped 1.9 percent.

Capacity utilization, a measure of slack in the economy, edged down to 74.7 percent, 4.2 percentage points above the year-ago level but still 5.9 points below the 1972-to-2009 average.

Although home-builder sentiment rose, the housing market remains weak and an investigation into improper processing of foreclosures carries the potential to slow its recovery as banks hold back on planned foreclosures.

"Sales do appear to be firming somewhat, but because of the backlog of foreclosures, it doesn't give us much 'oomph' in terms of construction," said Smith.

(Additional reporting by Corbett B. Daly; Editing by James Dalgleish)