A closely watched measure of consumer prices logged its biggest rise in nearly three years in May and a regional factory gauge contracted this month, showing the economy facing a troubling mix of weakness and inflation.

The Labor Department said on Wednesday its Consumer Price Index, excluding food and energy, increased 0.3 percent, the largest gain since July 2008, after rising 0.2 percent in April.

Core inflation was lifted by steep rises in motor vehicle and apparel prices. Analysts pointed to supply chain disruptions from Japan's earthquake as a factor behind the auto price rise.

Economists had expected the core CPI, which is closely watched by the Federal Reserve, to rise 0.2 percent. Overall inflation eased, rising 0.2 percent after a 0.4 percent gain in April, as energy prices finally fell.

Separately, the New York Federal Reserve Bank's Empire State index -- a measure of factory activity in New York state -- contracted for the first time since November, surprising economists who had expected a rise.

I assume people will look at this as another reason the recovery is stalling, giving more fodder to the double dip (recession) theory, said Paul Radeke, vice president at KDV Wealth Management in Minneapolis.

Other data has shown that the consumer remains on track, suggesting that eventually manufacturing will catch up. However, this data suggests that process will take longer.

In a third report, the Fed said production at the nation's mines, utilities and factories edged up 0.1 percent in May, restrained by a second consecutive drop in auto output, also pinned to trouble getting needed supplies.

Still, manufacturing output rose 0.4 percent, bouncing back from an April slide as factories made up for production lost due to tornadoes in the South.

U.S. stocks opened sharply lower on worries over the debt crisis in Greece and the weak reading on New York manufacturing, while bond prices climbed. Concerns over Greece and the stiff reading on core inflation helped lift the dollar against the euro.

The mixed data puts the Fed in a difficult position. Rising core inflation could pressure officials to begin unwinding some of their stimulus even as the recovery remains subdued.

The central bank concludes a $600 billion government bond-buying plan at the end of the month. Policymakers, who have faced intense criticism for risking inflation, have set the bar very high for any new program to aid the fragile economy.

GASOLINE PRICES FALL

The year-over-year core inflation index rose 1.5 percent in May, up from 1.3 percent in April and the largest increase since January 2010.

At the same time, overall prices increased 3.6 percent, reflecting a steep run-up in energy prices. It was the biggest 12-month gain since October 2008.

A Reuters poll published on Wednesday found economists expect consumer prices to rise 3.1 percent for the year as a whole. They see that easing to a 2.2 percent gain in 2012.

The core CPI is expected to rise 1.5 percent in 2011, and 1.9 percent next year, in line with the Fed's implicit inflation target.

Gasoline prices fell 0.2 percent last month after increasing 3.3 percent in April, but food prices rose 0.4 percent after increasing by the same margin in April.

Prices for new vehicles rose 1.1 percent last month -- the largest increase since October 2009, while apparel prices rose 1.2 percent, the biggest advance since February 2009.

Shelter costs, which account for about 40 percent of core CPI, rose 0.2 percent.

(Editing by Andrea Ricci)

Japan Inflation