Weak factories, sentiment show shaky U.S. recovery

Shoppers ride an escalator at a Target Store in Chicago, November 25, 2011.

WASHINGTON (Reuters) - Factory output contracted in May for the second time in three months and families took a dimmer view of their economic prospects in early June, signs that the economy's recovery is on shaky ground.

Data released on Friday was the latest in a series of weak economic reports that have led analysts to cut growth forecasts while raising expectations the U.S. Federal Reserve could launch new stimulus measures.

Until recently, manufacturing had been a buttress for the U.S. economy, helping it resist headwinds from Europe's snowballing debt crisis.

But in May, factory output shrank 0.4 percent, with U.S. plants producing fewer cars and less machinery, Federal Reserve data showed.

"It's more convincing evidence that the economy is stuck in low gear," said Joe Manimbo, a market analyst at Travelex Global Business Payments.

Other reports pointed to cooling factory activity in New York state this month, along with a drop in household confidence in the economy.

The fall in confidence poses a serious threat to President Barack Obama's chances of winning re-election in November. It could also lead consumers to cut back on spending, which would reduce economic growth.

"Consumers are scared," said Sharon Stark, managing director at Sterne Agee in Birmingham, Alabama.

U.S. consumer sentiment fell in early June to a six-month low. A gauge of household confidence in the economy's future also dropped to its lowest since December.

The Thomson Reuters/University of Michigan's index on consumer sentiment slipped to 74.1, falling short of even the most pessimistic forecast in a Reuters poll.

While manufacturing is an anchor of the economy, consumer spending is its foundation, accounting for about two-thirds of gross domestic product.

Economists at Capital Economics reckon the drop in consumer sentiment is consistent with growth in consumer spending slowing to a mere 1 percent annual rate in the second quarter, down from 2.7 percent in the first three months of the year.

EUROPE LOOMS

The slackening U.S. recovery and a worsening debt crisis in Europe have bolstered expectations of a further easing of monetary policy by the Fed, although economists are divided on whether the central bank will act when it meets on Tuesday and Wednesday.

Hiring by U.S. employers has slowed for four straight months, while retail sales contracted in May and new applications for jobless benefits have risen in five of the last six weeks.

Also looming over the outlook, Europe's snowballing debt crisis threatens to send the global economy into recession.

U.S. stocks rose, ending the week higher on hopes of collective action from global central banks if Sunday's election in Greece results in market turmoil.

Within the Fed's report on U.S. industry in May, the softness in the factory sector was widespread.

Output for durable - or long-lasting - goods dropped 0.5 percent as auto production slid 1.5 percent. Production of nondurables fell 0.2 percent.

Total industrial output, covering factories, mines and utilities, declined 0.1 percent. Analysts polled by Reuters had expected industrial production to rise 0.1 percent.

In a sign the factory sector's weakness could continue into June, the New York Federal Reserve Bank's "Empire State" index fell to 2.3, a 15-point drop from the previous month and the lowest level since November 2011.

That was far below economists' expectations of 13, although the level still points to some growth.

"That is another indication that the U.S. economy is slowing," said Justin Hoogendoorn, a fixed income strategist at BMO Capital Markets in Chicago. "It's an ugly situation."

(Additional reporting by Anna Louie Sussman and Richard Leong in New York; Editing by Neil Stempleman, Bernadette Baum and Dan Grebler)