American manufacturing output slipped in March and groundbreaking on homes fell, casting a shadow over the economic outlook.

The Federal Reserve said on Tuesday factory production slipped 0.2 percent last month, dragging on overall industrial output which was unchanged from a month earlier.

It looks pretty bad on the face of it, said Tom Porcelli, an economist at RBC Capital Markets in New York.

Still, Porcelli said the factory sector, which has been a key driver of the economy's recovery from the 2007-2009 recession, appeared to have enough momentum to continue growing.

Auto production, for example, increased 0.6 percent after rising 0.8 percent in February.

Housing starts slipped 5.8 percent in March to a seasonally adjusted annual rate of 654,000 units, the Commerce Department said in a separate report.

The long-moribund housing sector has showed signs of an incipient recovery in recent months, and homebuilding could add to economic growth this year for the first time since 2005.

Despite the drop in starts, the data suggests housing construction could still add to gross domestic product during the first quarter, said Millan Mulraine, a macro strategist at TD Securities in New York.

But an oversupply of unsold homes is depressing prices, creating a big hurdle for the sector, said Gregory Miller, an economist at Suntrust Banks in Atlanta.

It's going to be rocky for a while, Miller said, adding the data pointed at best to a tentative recovery.

Some analysts speculated that a mild winter in the United States led homebuilders to start new projects ahead of schedule, and that March's decline amounted to a payback.

Weather was so mild earlier in the year we might have pulled some of the starts forward, said Mark Foster, who helps manage $500 million at Kirr Marbach & Co in Columbus, Indiana.

But the trend looks good, it feels like the housing market is trying to form a bottom.

Stocks opened higher, helped by a drop in borrowing costs for Spain, which helped ease concerns about the European debt crisis. Prices for government debt fell.

March's decline in housing starts was the biggest percentage drop since April of last year, although most of the fall was in the volatile multi-unit category, which declined 16.9 percent.

Starts for single-family homes eased 0.2 percent.

And brightening the residential construction report's message on the economy, new permits for home construction surged.

Permits rose 4.5 percent to a 747,000-unit pace last month, the highest since September 2008 and beating economists' expectations for a 710,000-unit pace.

The rise in permits kind of offsets the disappointing data (on housing starts), said Omer Esiner, a market analyst at Commonwealth Foreign Exchange in Washington.

Sentiment among home builders ebbed in April for the first time in seven months, a survey showed on Monday.

(Additional reporting by Lucia Mutikani in Washington and by Julie Haviv, Ryan Vlastelica and Richard Leong in New York; Editing by Andrea Ricci)

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