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WRAPUP 4-U.S. producer prices down in June, output up

(Adds quotes, updates with closing market quotes, paragraphs 11-14)

WASHINGTON, July 17 (Reuters) - U.S. producer prices declined in June while industrial output bounced back, reports on Tuesday showed, setting a favorable tone for Federal Reserve Chairman Ben Bernanke’s testimony on the economy on Wednesday.

The separate reports from the Labor Department and the Fed were among a welter of data that implied the economy was shaking off the impact of a distressed housing sector and potentially adding steam after a soft first quarter.

The Labor Department said its producer price index that measures prices paid at the farm gate and factory door fell 0.2 percent after a 0.9 percent May jump.

But core prices, which strip out food and energy costs, climbed 0.3 percent after gaining 0.2 percent in May, weakening U.S. government debt prices as investors feared it reduced chances for cuts in official interest rates.

The Fed said output by U.S. factories, mines and utilities grew 0.5 percent in June, rebounding from a 0.1 percent May fall partly on a surge in production of new cars and trucks.

“Manufacturing in the United States is on the rebound,” said Lynn Reaser, chief economist for Bank of America’s investment strategies group in Boston. “Companies have worked through their inventories.”

But the housing sector still faces daunting problems, underlined on Tuesday by a report from the National Association of Home Builders that showed sentiment at its lowest level since January 1991. The builders’ group said the market for single-family homes was “still in a correction process” after a strong performance between 2003 and 2005.

HOUSING A THREAT

The president of the Kansas City regional Fed bank, Thomas Hoenig, told a Nebraska audience that a weak housing sector was a threat to the overall economy, especially if it causes consumers to pull back on spending.

On balance, he said there was “a very good outlook” for the U.S. economy and predicted growth at a rate modestly closer to its potential of 3 percent for the remainder of 2007. Growth during the first quarter was at an anemic 0.7 percent rate.

Stock prices gained on favorable earnings reports from big companies including Coca-Cola Co. KO.N and Merrill Lynch & Co. MER.N and on prospects for further profit gains.

The Dow Jones industrial average .DJI rose 0.15 percent to end at 13,971.55 after briefly topped 14,000 for the first time. The Nasdaq Composite Index .IXIC rose 0.55 percent to close at 2,712.29.

But U.S. government debt prices suffered as investor interest moved toward equities and amid fears that higher core prices meant the Fed will not reduce interest rates soon.

The benchmark 10-year U.S. Treasury note's price US10YT=RR eased 5/32 and its yield, which moves inversely to price, rose to 5.07 percent from 5.04 percent late Monday.

Prices for 30-year bonds fell 10/32 to yield 5.15 percent.

The producer prices report showed costs for energy goods overall fell 1.1 percent in June, a sharp reversal from May’s 4.1 percent jump and food costs fell 0.8 percent.

David Kelly, an economist with Putnam Investments in Boston, said the June producer prices report should ease concern about the possibility that rising food prices might trigger an inflationary spiral.

“This PPI number gets rid of one potential source of inflation for the economy,” Kelly said.

The Labor Department is scheduled to release its June Consumer Price Index on Wednesday at 8:30 a.m. (1230 GMT), which will show whether or not the price declines at the wholesale level are making their way through to store shelves.

FOREIGNERS STILL BUYING

A Treasury Department report showed foreigners remain upbeat about U.S. economic prospects, as overall capital inflows into the United States rose to $105.9 billion in May, driven by strong purchases of corporate bonds and equities.

The June industrial production figure topped the 0.4 percent rise that economists surveyed by Reuters had forecast.

“Last fall and into the winter, we did have an industrial slowdown,” said economist Ken Mayland of ClearView Economics LLC in Pepper Pike, Ohio. “Now it looks like we are out of the woods.”

Meanwhile, two reports on U.S. chain store sales showed sales picking up after a sluggish June.

Redbook Research said sales last week were 2.7 percent above the year-ago level, while the International Council of Shopping Centers and UBS Securities said in a joint report that sales rose 3.4 percent year-on-year. (Additional reporting by Richard Leong, David Lawder, Joanne Morrison and John Parry)

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