Factory data stokes worry amid financial turmoil

NEW YORK (Reuters) - U.S. industrial output posted its biggest slide in three years last month and September might not be much better, according to data on Monday that raised worries over an economy struggling with the worst bout of financial turmoil in a generation.

U.S. industrial production tumbled a bigger-than-expected 1.1 percent in August due to a big drop in auto production and a slide in utilities output that was tied to mild temperatures, a Federal Reserve report showed.

Manufacturing in New York state unexpectedly contracted in September while price pressures tumbled, according to separate data published by the New York Federal Reserve. The survey is one of the earliest monthly guideposts to U.S. factory conditions.

The data stoked worries that the U.S. economy is still flirting with recession even though gross domestic product growth was a solid 3.3 percent in the second quarter.

"The evidence of declining third-quarter GDP continues to mount. There will likely be a partial rebound next month, but production is likely to be sharply lower for the quarter," said Christopher Low, chief economist at FTN Financial in New York

However, financial markets showed little reaction to the data, with investors preoccupied by news that investment bank Lehman Brothers LEH.N filed for bankruptcy protection.

U.S. stocks plunged. Government bonds -- investors' favorite safe haven during uncertain financial times -- were sharply higher.

The dollar remained stronger against the euro as markets bet U.S. troubles would spread throughout the world economy.

The drop in August was the biggest decline in industrial production, which includes factories, mines and utilities, since September 2005. Analysts were expecting a 0.3 percent slide.

Manufacturing output fell 1 percent, also the largest decrease in three years, as auto production plummeted by 11.9 percent.

OUTPUT

Output at utilities slid 3.2 percent because of a milder-than-usual August, the Fed said. It was the sharpest drop in utilities output since March. Production at mines slipped 0.4 percent.

Capacity utilization, a measure of how close to flat out factories are running, slipped to a smaller-than-expected 78.7 percent, the lowest since October 2004. Analysts had forecast a 79.6 capacity use rate.

Industrial production in June and July were revised down to show smaller gains of 0.2 percent and 0.1 percent, the Fed said.

Precautionary shutdowns in the Gulf of Mexico in advance of Hurricane Gustav curtailed refinery activity and oil and gas extraction, but the effect on total industrial production was less than 0.1 percent, the government said.

Capacity utilization is 2.3 percentage points below its 25-year average, the Fed said.

In a separate report, the New York Fed's "Empire State" general business conditions index fell to minus 7.41 in September -- its lowest since minus 8.68 in June -- from 2.77 in August.

Economists polled by Reuters had expected a reading of plus 1.50. The silver lining to the report was that it showed a sharp fall in inflation pressures, with the prices paid index posting its biggest drop since the survey began in 2001.

(Additional reporting by Mark Felsenthal in Washington and Richard Leong in New York; Editing by Andrea Ricci)