WRAPUP 4-US CPI, production data point to easing recession

* U.S. CPI flat, industrial output drop eases in April

* Consumer prices post biggest 12-month drop since 1955

* Consumer sentiment perks up, strongest since September

* Capacity utilization lowest on records dating to 1967 (Updates with closing market prices)

By Lucia Mutikani and Emily Kaiser

WASHINGTON, May 15 (Reuters) - U.S. economic data offered more evidence on Friday that the recession's worst phase may be over, with April consumer prices unchanged and industrial output declining at a slower pace than in March.

Signs that the 17-month-old recession may be nearing an end helped push consumer confidence in May to its highest since the collapse of investment bank Lehman Brothers last September.

Further dissipating the gloom, the contraction in New York state factory activity eased this month.

"The more data we are seeing, it's not a doomsday scenario. Yes, we are still in a recession, but we may be in the stage of pre-recovery," said Andrew Richman, fixed-income strategist at SunTrust Private Wealth Management in Palm Beach, Florida.

However, U.S. stocks fell as investors skimmed profits off the market's two-month rally from 12-year lows in early March. The Dow Jones industrial average .DJI ended down 62.68 points at 8,268.64, while the Standard & Poor's 500 Index SPX dropped 10.19 points to 882.88.

Government bond prices slipped and benchmark yields US10YT=RR, which move inversely, pushed off two-week lows.

The Labor Department said the U.S. Consumer Price Index was flat last month, as expected, after edging 0.1 percent lower in March. Compared with the same period last year, consumer prices fell 0.7 percent, the biggest 12-month drop since June 1955.

Rising unemployment is eroding household income and undercutting consumer demand. The virtual absence of demand and the general slack in the economy have robbed companies of pricing power, keeping inflation low and increasing concerns about a possible dangerous downward spiral in prices.

The CPI report offered something to think about both for those who are worried about falling prices and those who are concerned about the risk of inflation as a flood of money to stimulate demand flows through the economy.

"At the same time that the contraction in growth is slowing, you have a massive amount of spare capacity in the economy," said Zach Pandl, an economist at Nomura Securities International in New York.

"Even though it looks like the recession is coming to an end and we're headed towards growth in the second half, those medium-term deflation risks have not gone away yet."