Philly Fed factory index tumbles in February

NEW YORK (Reuters) - Factory activity in the U.S. mid-Atlantic region crashed to an 18-year low in February, underperforming economists' worst expectations as the year-old recession continued to exact a heavy toll on manufacturing.

The Philadelphia Federal Reserve Bank reported on Thursday that its business activity index tumbled to minus 41.3 from negative 24.3 in January.

"This is grim," said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York.

Any number below zero indicates contraction in the region's manufacturing sector.

The deterioration was led by falling new orders and unemployment, with the survey's jobs gauge hitting its lowest since the survey's launch in 1968.

On Wall Street, stocks cut their gains after the surprisingly weak report.

Government bonds, which generally benefit from weak data, were lower on the day, but mainly because investors were worried about the enormous borrowing the Treasury will need to do to pay for its economic recovery efforts.

News in the report of bloated inventories suggested tough slogging ahead for companies, as this can mean they must sell off stockpiled goods before they can consider increasing production.

In special questions this month, firms were asked about their current inventory situation. Nearly 44 percent indicated inventories were too high and were expected to decrease during the first quarter.

If there was any silver lining to the report it was the gauge of six-month business conditions, which rose to 15.9 from 7.4.

However, given the dismal state of the economy -- and manufacturing in particular -- economists are likely to await actual improvement in conditions before adopting a more optimistic view.

Economists had expected a result of minus 25.0, according to the median of 47 forecasts in a Reuters poll, which ranged from minus 34.0 to negative 20.0.

The survey of factories in eastern Pennsylvania, southern New Jersey and Delaware is seen as one of the first monthly indicators of the health of the U.S. manufacturing sector.

(Editing by James Dalgleish)