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 data, economists said consumer spending likely rebounded in the first quarter, which could mean gross domestic product fell less steeply than the 6.3 percent annual rate recorded in the last three months of 2008.

Federal Reserve Chairman Ben Bernanke, meanwhile, said figures released in the last few weeks 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 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 over 7 percent. The Dow Jones industrial average ended down 137.63 points at 7,920.18. U.S. government bond prices rose as investors bailed out of stocks.

NOT OUT OF THE WOODS

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

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

Weekly retail sales reports suggest consumers were shopping again in early April. U.S. chain stores sales rose 0.8 percent last week, building on the previous period's 0.6 percent gain, according to the International Council of Shopping Centers.

Separately, the Johnson Redbook retail sales index climbed 0.9 percent in the first week of April after rising 0.4 percent the previous week.

It still represents a net positive for first-quarter GDP. 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, said Stuart Hoffman, chief economist at PNC Financial in Pittsburgh.

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

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, reversing 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 following a decline of a similar margin the prior month. Motor vehicle and parts inventories dropped l.3 percent in February.

This should begin to reduce the rate of decline in output, although no meaningful increase in output is likely until inventories are brought down significantly more, said Tony Crescenzi, chief bond market strategist at Miller Tabak & C0. in New York.

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.

(Additional reporting by Alister Bull; Editing by Chizu Nomiyama)

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