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 ended down 62.68 points at 8,268.64, while the Standard & Poor's 500 Index dropped 10.19 points to 882.88.

Government bond prices slipped and benchmark yields, 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 toward growth in the second half, those medium-term deflation risks have not gone away yet.

DIMINISHING DEFLATION RISKS

The Fed, which has pumped more than $1 trillion into the economy in a bid to break its downward spiral, is worried about deflation although it sees the risks as diminishing.

While the headline inflation figure was flat, and economists widely expect negative readings later this year, core prices, which exclude food and energy items, rose 0.3 percent after gaining 0.2 percent in March.

That was driven largely by a second consecutive large increase in the cost of tobacco as a government excise tax went into effect, and a gain in new vehicle prices, which have risen for four consecutive months despite the slump in sales.

Analysts said the rise in new vehicle prices would soon run out of steam, citing steps by auto makers Chrysler and General Motors to slash their dealer networks. This would cause liquidations of new vehicles at distressed prices, they said.

A separate report from the Fed showed production at U.S. factories, mines and utilities fell 0.5 percent last month, the sixth consecutive monthly decline, but a more modest drop than in recent months. A month earlier, output slid 1.7 percent.

The capacity utilization rate for total industry, a measure of slack in the economy, fell to 69.1 percent in April, the lowest level on records dating back to 1967.

Some analysts said extended auto plant shutdowns could mean industrial output will resume a steeper pace of descent. Chrysler has closed its 30 plants since filing for bankruptcy last month and GM plans some extended closures this summer.

The combined production cuts by automobile assemblers and parts and materials suppliers over the summer will keep total industrial production very weak through the second quarter and likely into the third quarter of this year, said Robert Dye, senior economist at PNC Financial in Pittsburgh.

We have a ways to go here before we really start to see signs of stabilization and even before we start to see signs of recovery in the economy.

Still, there have been a number of indications hinting the economy's downdraft may be slowing.

The Reuters/University of Michigan preliminary index of consumer confidence for May, released on Friday, rose to 67.9 from 65.1 in April.

In another report, the New York Federal Reserve Bank said its New York State index of manufacturing activity rose to minus 4.55 in May, its highest since August 2008, a month before Lehman's collapse triggered a deep global slump.

(Additional reporting by Richard Leong and Chris Reese in New York; Editing by James Dalgleish)

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