Sales at U.S. retailers unexpectedly fell 1.1 percent in March after rising for two straight months, government data showed on Tuesday, dimming hopes the 16-month-old recession was close to hitting bottom.

A separate report showed prices received by U.S. producers fell a surprising 1.2 percent last month, underscoring the economy's weakness and lack of pricing power.

Despite the weak March sales report, economists said consumer spending likely rebounded in the first quarter, which could mean gross domestic product declined less steeply than the 6.3 percent annual rate recorded in the October-December quarter.

Federal Reserve Chairman Ben Bernanke, meanwhile, said the latest figures on housing and consumer spending suggest signs of improvement. Recently we have seen tentative signs that the sharp decline in economic activity may be slowing. A leveling out of economic activity is the first step toward recovery, Bernanke said in remarks prepared for delivery later on Tuesday.

The Commerce Department said March retail sales were weighed down by declining purchases for big-ticket items like motor vehicles and electronic goods. It said February retail sales were revised upward to show a 0.3 percent gain, from a previously reported fall of 0.1 percent, while January's figures were adjusted to show a hefty 1.9 percent rise.

I don't think the recession is close to a bottom, but I do believe the rate of decline is slowing and it will slow very sharply, said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. Before we write off the consumer, we need to see what happens with the April numbers.

U.S. stocks fell on the data, with shares of department store chain Macys dropping nearly 8 percent. U.S. government bond prices rose as investors pulled out of riskier assets, and gave the U.S. dollar a lift versus the euro on safe-haven flows.

President Barack Obama said on Tuesday there were signs of recovery in the economy, but by no means are we out of the woods yet.

EASTER A FACTOR

Economists argued the March sales, which showed declines across the board, had been negatively affected by Easter falling in April and did not weaken the argument that consumer spending was stabilizing after massive drops in the second half of 2008.

The good news in today's retail sales report is that it still represents a net positive for first-quarter GDP, said Stuart Hoffman, chief economist at PNC Financial in Pittsburgh, Pennsylvania.

Stronger-than-expected January and February sales point to a small gain of close to 1.0 percent annually in real personal consumption expenditures for the first quarter.

Consumer spending accounts for over two-thirds of U.S. economic activity. The housing-led recession, characterized by steep job losses and plunging asset values, is forcing households to scale back consumption.

Retail sales had risen for two consecutive months and recent data on the housing sector has also brightened, giving way to cautious optimism among economists that the downturn was close to reaching a bottom.

Excluding motor vehicles and parts, sales fell 0.9 percent in March, compared to a 1 percent gain the prior month. The data highlighted the continuing problems in the U.S. auto industry, with vehicle and parts sales dropping 2.3 percent after a 3 percent decline in February.

Gasoline sales fell 1.6 percent in March after increasing by 3.1 percent the previous month.

Sales of electronic goods and appliances tumbled 5.9 percent, versus a 0.7 percent gain in February, while building materials eased 0.6 percent after slipping 0.5 percent.

In another report, the Commerce Department said U.S. business inventories fell 1.3 percent in February after declining by a similar margin the prior month. Motor vehicle and parts inventories dropped l.3 percent in February.

Separately, the Labor Department said U.S. producer prices fell 1.2 percent in March and compared with the same period a year ago slumped 3.5 percent, the largest decline since 1950.

Core producer prices, which exclude food and energy costs, were unchanged in March. The core producer price index stood 3.8 percent higher from the same month last year.

The message from the PPI report is that the risk at the moment is still deflation, rather than inflation, said IHS Global Insight's Gault.

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