Consumer prices fell in October for the first time in four months, taking pressure off strapped households and giving the Federal Reserve more room to ease monetary policy if the economy falters.

For now, economic growth is gaining traction and a separate report on Wednesday showed industrial output rebounded strongly last month as factories ramped up production.

The consistent theme in the recent flow of economic data has been one of accelerating momentum in economic activity, said Millan Mulraine, a senior macro strategist at TD Securities in New York.

Nevertheless, the concern for the recovery continues to be about what happens in Europe, as any escalation in the unfolding debt crisis could present a significant obstacle for the economic recovery.

The Labor Department said consumer prices dropped 0.1 percent last month as Americans paid less for new cars and gasoline.

The data reinforces the view that inflation is poised to trend lower following a spike in oil prices earlier in the year. That is seen giving the Fed more room to act if the economy slows.

The Fed remains intently focused on employment and growth -- and not on inflation, said Jacob Oubina, an economist at RBC Capital Markets in New York.

The drop in prices during October gave a boost to workers whose wages failed to keep up with inflation over the summer, which had led households to save less.

A separate report by the Labor Department showed weekly earnings rose 0.3 percent in October when accounting for inflation.

Stronger incomes could help consumer spending as the year closes, giving the economy a little more momentum as the country braces for a possible recession in Europe that would drag on growth.

Major U.S. stock indexes were lower on worries about Europe's debt problems, while Treasuries prices rose. The dollar was higher against the euro.

HEADWINDS

A storm is gathering over the global economy as Europe struggles to contain a snowballing sovereign debt crisis. The U.S. economy has been gaining steam since the summer, but a blowup of Europe's problems could drag the U.S. back into recession.

A separate report from the Fed showed industrial production rose 0.7 percent last month, beating economists' expectations.

Home builders in the United States grew more optimistic this month but still thought sales conditions were poor, according to the National Association of Home Builders/Wells Fargo Housing Market index released on Wednesday.

The data is relatively upbeat in the U.S., which contrasts with the situation in Europe, said Omer Esiner, a strategist at Commonwealth Foreign Exchange in Washington.

President Barack Obama urged European leaders to act boldly to stem the crisis as bond market contagion spread throughout the region, while France and Germany clashed over the role of the euro zone's central bank.

The Fed report also showed factory output accelerated in October, rising 0.5 percent on an increase in production of motor vehicles and parts. Even with U.S. factories operating closer to full capacity than at any time since July 2008, there was little sign of inflationary pressures in the factory data.

Also looming over the economic outlook, U.S. lawmakers are debating whether to let tax cuts and some unemployment benefits expire at the end of year, which would drag on growth.

Inflation is expected to fall sharply over the next year.

In the 12 months through October, consumer prices rose 3.5 percent after rising 3.9 percent in the full year through September.

Investors and economists expect that reading will fall to 1.3 percent by November of 2012, the Cleveland Federal Reserve Bank said in a report.

For now though, a measure of prices closely watched by the Federal Reserve remains uncomfortably high.

Prices outside food and energy climbed 0.1 percent in October, pushing the so called core reading for 12-month inflation up to 2.1 percent. The Fed would like that reading to trend at 2 percent or just below.

Still, the headwinds to U.S. growth appear strong enough that the Fed could be forced to act before long.

At this point it would probably take only a few missteps out of elected Washington or the capitals of Europe before Fed leadership sees the need for more aggressive action, said Michael Feroli, an economist at J.P. Morgan.

(Additional reporting by Lucia Mutikani in Washington and Emily Flitter in New York; Editing by Andrea Ricci and Neil Stempleman)

Fall