By Lucia Mutikani
WASHINGTON (Reuters) - U.S. industrial production unexpectedly fell in May as manufacturing and mining activity remained weak, a sign that a strong dollar and spending cuts in the energy sector continued to constrain economic growth.
The softness in the production side of the economy contrasts starkly with recent upbeat data on retail sales, employment, consumer and small business confidence, which have pointed to a growth pickup after a sluggish start to the second quarter.
"Signs of spring remain largely absent in the industrial sector. The challenges of the stronger dollar and drop in energy prices linger," said Tim Quinlan, an economist at Wells Fargo (NYSE:WFC) Securities in Charlotte, North Carolina.
Industrial output slipped 0.2 percent last month after declining 0.5 percent in April, the Federal Reserve said on Monday. Industrial production has been weak since December, and economists had expected output to rise 0.2 percent last month.
The data was likely to get the attention of Fed policymakers who meet on Tuesday and Wednesday, economists said.
The U.S. central bank is not expected to raise interest rates at this week's policy meeting, but rather to wait until later this year.
Industrial production last month was held down by a 0.2 percent drop in manufacturing output. Manufacturing has been whacked by a strong dollar, which has eroded the profits of multinational corporations.
Companies like Microsoft Corp (O:MSFT) and Procter & Gamble Co (N:PG), the world's largest household products maker, and healthcare conglomerate Johnson & Johnson (N:JNJ) have warned the dollar will hit sales and profits this year.
The dollar has gained about 13.2 percent against the currencies of the United States' main trading partners since last June largely on expectations of tighter U.S. monetary policy.
U.S. financial markets were little moved by Monday's data as investors kept a wary eye on Greece, which inched closer to defaulting on its debt. U.S. stocks were trading lower, while the dollar slipped against a basket of currencies. Prices for U.S. government debt rose.
WEAK ORDERS
Although motor vehicle production, machinery, and computer and electronic products increased last month, it was not enough to offset the drag on manufacturing output from declines in the production of electrical equipment, appliances and components, fabricated metal products and wood products.
Manufacturing, which accounts for 12 percent of the U.S. economy and more than 72 percent of industrial production, was also weighed down by falling output of nondurable goods such as food and petroleum products.
It is likely to remain weak in the months ahead.
In a separate report, the New York Fed said its Empire State general business conditions index dropped to a reading of minus 1.98 in June from 3.09 in May.
That was the weakest reading since January 2013 and the second negative reading in the past three months. A gauge of new orders contracted, while shipments edged down. Though a measure of unfilled orders increased last month, it remained in contraction territory, indicating order books remained weak.
"Manufacturers will continue to struggle with the impact of the dollar's rise for some time yet," said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.
But given manufacturing's small share of the economy and recent signs of a sharp pickup in growth in the non-factory sectors, Ashworth said "there is every reason to believe that GDP growth will average between 2.5 percent to 3.0 percent annualized over the rest of this year."
That upbeat assessment was bolstered by a third report showing confidence among homebuilders vaulted to an eight-month high in June, suggesting the housing market recovery was gaining traction. Housing is expected to take up some of the slack from weak manufacturing.
GDP contracted in the first quarter, slammed by bad weather, port disruptions, dollar strength and energy sector spending cuts.
Last month, mining production fell 0.3 percent, the fifth straight monthly decline, as oil and gas well drilling and servicing fell 7.9 percent after plunging 14.5 percent in April.
That took the cumulative drop since the end of 2014 to 51.8 percent. But the pace of decline in oil and gas well drilling and servicing is moderating, suggesting the worst of the spending cuts is over.
Companies like Schlumberger (N:SLB), the world's No. 1 oilfield services provider, and Halliburton (N:HAL) have slashed their capital spending budgets for this year.
Oil and gas production, however, increased 0.5 percent in May. Unseasonably warm weather last month lifted demand for air conditioning, leading to a 0.2 percent increase in utilities production.
The amount of industrial capacity in use last month fell to its lowest level since January 2014.