U.S. industrial output declined at a slower pace in June and a key regional U.S. factory survey posted its strongest reading in a year this month, suggesting the recession was loosening its grip.

Another report on Wednesday showed core U.S. consumer prices edged up at a moderate pace in June.

Prices for U.S. government bonds fell and yields rose after the New York Federal Reserve's Empire State general business conditions index rose to minus 0.55 in July from minus 9.41 in June, as investors took encouragement that manufacturing was improving.

July's report on factory activity in New York state was the strongest since April 2008, the last time it was in positive territory. That also exceeded economists' expectations of minus 5.0, based on the median of forecasts in a Reuters poll.

The improvement in factory sentiment was boosted by a big jump in the new orders index to 5.89 from June's minus 8.15, reaching its highest since December 2007.

The improvement came as the inventories index fell to minus 36.46 -- a record low, according to the New York Fed. In June, it was at negative 25.29.

Economists have expected plummeting inventories to lead to a rebound in production and possibly help pull the U.S. economy out of the worst recession in decades.

It's still a tentative sign, but consistent with other reports showing that the recession may be near an end, said Gary Thayer, senior economist at Wells Fargo Advisors in St. Louis.

A separate report from the Federal Reserve showed industrial output fell by a smaller-than-expected 0.4 percent in June, reinforcing hopes that the pace of recession had slowed in the second quarter.

Economists polled by Reuters had expected a 0.6 percent decline in industrial production.

For the second quarter as a whole, output fell at an annual rate of 11.6 percent, a more moderate contraction than in the first quarter when production fell at a 19.1 percent rate.

The U.S. economy shrank at a 5.5 percent annual pace in the first quarter. But this rate of decline is expected to moderate sharply in the second quarter, with growth returning gradually in the second half of the year, aided by a rebound in stock building as inventory liquidations slow.

The recession has dampened inflation, but the worry that the downturn could spur a Japan-style deflation has abated.

Consumer prices rose at a slightly faster-than-expected 0.7 percent pace in June, although most of the increase was due to soaring gasoline prices, and the core measure of inflation remained relatively tame.

The Labor Department said the rise in the Consumer Price Index was the largest since July 2008. Wall Street analysts polled by Reuters had forecast a 0.6 percent increase, compared with the 0.1 percent gain reported in May.

Gasoline prices jumped 17.3 percent last month, the largest increase since September 2005.

Compared to the same period last year, consumer prices fell 1.4 percent, the biggest decline since January 1950 when prices fell 2.1 percent, a Labor Department official said. Gasoline prices compared with a year ago were 34.6 percent lower.

Stripping out volatile energy and food prices, the closely watched core measure of consumer inflation rose 0.2 percent in June, which was slightly more than the 0.1 percent forecast increase. Core prices compared with a year ago rose 1.7 percent, the smallest rise since a matching gain in January.

The year-over-year increase of 1.7 percent ex-food and energy clearly shows that last year's deflation fears should now be solidly over, said Tom Sowanick, chief investment officer at Clearbrook Partners in Princeton, New Jersey.

(Additional reporting by Jennifer Ablan and Ellen Freilich in New York)

(Reporting by Alister Bull, Editing by Andrea Ricci)

Manufacturing Inflation