Factories flex muscle post storm, inflation subdued

Factory output posted its sharpest increase in nearly a year in November as auto production staged a rebound, while consumer prices slipped, offering cautious optimism for the struggling economic recovery.

A separate report on Friday bolstered the view that a slowdown in manufacturing may have run its course. Factories have bounced back after being held down by Superstorm Sandy, which struck the East Coast in late October.

Despite last month's rise, factory production remained below highs reached earlier this year. Analysts said this subdued recovery and tame price pressures provide ample scope for the Federal Reserve to stay on its ultra-easy monetary policy path.

"This is an economy that still has a lot of slack and upside potential," said Robert Dye, chief economist at Comerica in Dallas. "There is a lot of dry tinder out there, the Fed has added to that with monetary policy and we have to get past the fiscal cliff issues to see if the dry tinder catches fire."

The fiscal cliff refers to the $600 billion in deep government spending cuts and tax hikes that will hit the economy next year if the Obama administration and Congress fail to agree on a less drastic plan to reduce budget deficits.

Manufacturing output rose 1.1 percent in November, the biggest gain since December 2011 and a rebound from a 1.0 percent drop in the prior month, the Fed said. It said production was lifted by a surge in motor vehicle output.

Sandy had weighed on overall industrial output in October, but the snapback in November was stronger than economists had expected. Output at the nation's factories, mines and utilities taken together also jumped 1.1 percent after slumping 0.7 percent in October. It was the biggest gain in almost two years.

Separately, financial information firm Markit said its preliminary gauge of factory activity in December rose to 54.2, its highest level since April, from 52.8 in November.

"Going forward, output will largely be determined by what type of resolution is reached on the fiscal cliff," said Brett Ryan, a U.S. economist at Deutsche Bank Securities in New York.

"If policymakers do not come up with a solution, the recovery in industrial production may prove to be fleeting."

BENIGN INFLATION ENVIRONMENT

In a third report, the Labor Department said its consumer price index dropped 0.3 percent in November, the first decline in six months, as gasoline prices fell sharply.

The so-called core CPI, which excludes food and energy prices, edged up 0.1 percent after rising 0.2 percent in October. Although food prices rose 0.2 percent in a lagged response to the summer drought, price pressures remained tame.

"The inflationary backdrop remains very benign, providing the Fed with considerable breathing room to keep monetary policy accommodative," said Millan Mulraine, a senior economist at TD Securities in New York.

The central bank said on Wednesday it expected to hold interest rates near zero until the unemployment rate falls to at least 6.5 percent as long as inflation does not threaten to break above 2.5 percent.

U.S. stocks were little changed as the data failed to dispel worry on Wall Street over the fiscal cliff. Prices for U.S. government debt rose as traders saw the inflation data supporting an easy Fed policy, while the dollar fell broadly.

GASOLINE COSTS DROP

In the 12 months through November, consumer prices increased 1.8 percent, the smallest gain since August and a slowdown from the 2.2 percent rise in the period through October. It has slowed from nearly 3 percent in January.

Last month, gasoline prices tumbled 7.4 percent, the largest drop since December 2008, after falling 0.6 percent in October.

The drop in gasoline prices eased some of the strain on household budgets. The Labor Department said inflation-adjusted average weekly earnings rose 0.5 percent last month, reversing October's 0.5 percent fall.

Away from gasoline, the cost of apparel fell for the first time in two months, while new motor vehicle prices saw their first rise since August. Auto prices could have been lifted by a spike in demand as people replace vehicles destroyed by Sandy.

Prices for used cars and trucks fell for a fifth straight month, while housing costs edged up.

In the 12 months through November, the core CPI increased 1.9 percent after rising 2.0 percent in October.

"The current disinflationary trend, and the fact that wage and upstream price pressures are almost non-existent, suggests that core inflation will probably remain below the Fed's target for most of 2013," said Jeremy Lawson, a senior economist at BNP Paribas in New York.

The Fed targets an inflation rate of 2 percent, but uses a separate gauge that tends to run a little lower than the CPI.

(Additional reporting by Anna Yukhananov in Washington and Steven C. Johnson in New York; Editing by Andrea Ricci)