U.S. consumer prices fell in March, posting their first 12-month drop in nearly 54 years, and industrial production slipped further, according to data on Wednesday that underscored the severity of the recession.

However, the Federal Reserve said economic activity in some parts of the economy appeared to be stabilizing, and other data showed that a decline in factory activity in New York state eased this month and that national homebuilder sentiment jumped, suggesting the economy's steep descent may be slowing.

Today's indicators are consistent with the early stages of a bottoming-out process in the U.S. economy, said Stuart Dye, a senior economist at PNC Financial Services in Pittsburgh.

U.S. stock prices rose, with the Dow Jones industrial average <.DJI> ending up 1.4 percent at 8,029.62. U.S. government bond prices edged higher with traders focusing mostly on the inflation and industrial output data.

Analysts cautioned, however, that the economy faces a long road back to health from a 16-month-old recession that is set to become the longest since the Great Depression next month.

The data on consumer prices and industrial output showed the degree to which anemic demand had eroded companies' pricing power and left the economy burdened with excess capacity.

Although there has been some improvement in economic data recently, the recession is still ongoing. What we are seeing is a big increase in excess capacity in the economy, said Zach Pandl, an economist at Nomura in New York.

PRICE PRESSURES CAPPED

The Labor Department said its Consumer Price Index fell 0.1 percent last month, after rising 0.4 percent in February.

On a year-over-year basis, consumer prices dived 0.4 percent, the first 12-month decline since August 1955, as weak demand undercut energy prices.

In a separate report, the Fed said output at the nation's factories, mines and refineries dropped 1.5 percent in March as businesses pared orders and cut inventory. For the first quarter, production plunged at an annual rate of 20 percent.

Highlighting the economy's poor state, Burger King Holdings Inc reported a surprise decline in customer visits to its restaurants in March, while the world's largest retailer, Wal-Mart Inc , said it saw no quick end to the recession.

Economists reckon that falling domestic output and mounting unemployment will limit price increases throughout 2009.

Energy prices dropped 3 percent in March after rising 3.3 percent the previous month, while the food index eased 0.1 percent for a second straight month.

A report on Tuesday showed U.S. producer prices fell 1.2 percent last month, but analysts on Wednesday pointed to a third straight monthly rise in so-called core consumer prices -- stripping out volatile food and energy costs -- and saw no imminent threat of a disabling deflation taking hold.

Core prices in March rose 0.2 percent to stand 1.8 percent above their year-ago level. A rise in the cost of tobacco accounted for more than 60 percent of last month's increase.

INVENTORY CYCLE

Although output fell for a sixth straight month in March, pushing the amount of the nation's industrial capacity being used to a record low 69.3 percent, analysts said this reflected an aggressive effort by businesses to pare inventories, which could lay the groundwork for an eventual pickup in growth.

Fairly soon they will finish getting their inventories down to levels that they want and they will start putting in new orders (but) it's hard to predict when that will be, said Bill Cheney, chief economist at John Hancock Financial Services in Boston, adding:

One could hope that we are just at the point where we might be turning the corner but it's way too early to be sure.

The Fed said in its Beige Book, a monthly compilation of anecdotal information from the U.S. central bank's business contacts, that the drop in activity in five of its 12 regional districts appeared to be slowing.

Five of the 12 districts noted a moderation in the pace of decline, and several saw signs that activity in some sectors was stabilizing at a low level, it said.

Separately, the New York Federal Reserve Bank said its Empire State general business conditions index was minus 14.65 in April, compared with a record low of minus 38.23 in March, an indication the drop in New York state factory activity was slowing.

Helping bolster views the economy's deep downturn was easing, the National Association of Home Builders said its index of U.S. home builder sentiment rose five points to 14 in April, the highest since last October and the largest monthly increase since May 2003.

(Additional reporting by Emily Kaiser and Alister Bull in Washington and Richard Leong in New York; Editing by James Dalgleish)

Inflation