U.S. consumer confidence hit a near 2-1/2 year low in early July and manufacturing output stalled in June, further frustrating expectations of a quick economic growth rebound in the second half of the year.

Worries about stubbornly high unemployment pushed the Thomson Reuters/University of Michigan's index of consumer sentiment to 63.8, the lowest since March 2009, a report showed on Friday. Economists had expected the index to climb to 72.5 from 71.5 in June.

Separate data from the Federal Reserve showed manufacturing output stagnated last month partly due to supply disruptions in the auto sector related to the earthquake in Japan.

The reports were the latest in a series, including weak retail sales and employment, to suggest the anticipated step-up in growth in the second half of the year might not be as strong has initially thought.

We still expect an improvement in the second half, but the question is how much can we grow? said Yelena Shulyatyeva an economist at BNP Paribas in New York. Our view is the rebound is not going to be anything like in the prior cycles because we are growing at a lower potential rate right now.

Fed Chairman Ben Bernanke said this week the U.S. central bank was prepared to act if growth falters further, but made it clear that Fed is not at that point yet.

The economy was slammed by a combination of high commodity prices and bad weather, causing growth to slow sharply to a 1.9 percent annual rate in the first quarter after a brisk 3.1 percent expansion in the final three months of 2010.

Disruptions to motor vehicle production and still high gasoline prices are expected to have held growth to a pace between 1.5 percent and 2 percent in the second quarter.

The government will release its initial second quarter gross domestic product estimate on July 29.

Manufacturing in the second quarter posted its weakest rise since the recession ended in mid-2009. There are indications that manufacturing maintained its weak tone as the third quarter started.

The New York Fed's gauge of factory activity was at minus 3.76 in July from minus 7.79 in June, another report showed. That could suggest that some of the factors weighing on manufacturing are not of a temporary nature.

GASOLINE PRICES TUMBLE

The decline in consumer sentiment, which came even as gasoline prices have dropped from their peak above $4 a gallon in May, does not bode well for consumer spending.

Consumer spending accounts for about 70 percent of U.S. economic activity and has been constrained by high gasoline prices and a 9.2 percent unemployment rate. Employers last month added a paltry 18,000 jobs.

Bickering over raising the country' debt ceiling is also adding to economic uncertainty.

Stocks on Wall Street gave up much of their earlier gains. Prices for U.S. government debt pared earlier gains after the European Banking Authority said eight banks failed capital stress tests, fewer than what traders had feared. The dollar fell against a basket of currencies.

SOME POSITIVE SIGNS

On Friday, Citigroup became the second major U.S. lender to show significant growth in outstanding corporate loans, a potential source of growth of the economy. Citigroup's corporate loan portfolio grew 4.4 percent to $205 billion at the end of June from three months earlier.

On Thursday, JPMorgan Chase & Co. reported that business loans increased 5.4 percent in the same three months to $249 billion.

Hard pressed consumers could get a reprieve from declining commodity prices. Labor Department data showed the Consumer Price Index fell 0.2 percent in June as gasoline prices tumbled by the most since December 2008.

The drop in consumer prices was the largest in a year and followed a 0.2 percent increase in May.

Stripping out food and energy, however, core CPI rose 0.3 percent after a similar gain in May. The rise in core inflation reflected a lagged pass-through from high commodity prices and economists saw no threat of an upward spiral in price pressures.

In the 12 months to June, core CPI rose 1.6 percent after increasing 1.5 percent in May. Fed officials would like to see that closer to 2 percent.

Inflation is not a major issue, (a) lot of the factors behind the rise are transitory, said Steven Rick, senior economist at the CUNA in Madison, Wisconsin.

Wage growth remains benign, with average hourly earnings flat in June. In the 12 months through June average hourly earnings rose 1.9 percent. In addition capacity utilization by factories was unchanged in June, pointing to ample slack in the economy.

Last month, core inflation was pushed up by rising prices for housing, new vehicles, used trucks and apparel. Apparel prices recorded their biggest jump since March 1990, while the rise in used cars and trucks was the biggest in more than 1-1/2 years.

(Additional reporting by Pedro Nicolaci da Costa in Washington, and David Henry and Leah Schnurr in New York)

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