By Lucia Mutikani
WASHINGTON (Reuters) - U.S. industrial output posted its biggest drop in more than 2-1/2 years in March in part as oil and gas well drilling plummeted, highlighting the negative impact of lower crude prices and a strong dollar on the economy.
The dour report from the Federal Reserve on Wednesday was the latest sign that growth slowed sharply in the first quarter and suggested the U.S. central bank could delay raising interest rates until later this year.
Snowy winter weighed on activity early in 2015. Labor disruptions at normally busy West Coast ports, as well as the dollar and softer global demand have been a constraint.
"This provides some confirmation on the disappointing growth performance in the first quarter. The absence of a lift in the other forward-looking indicators suggests that the U.S. economic recovery is struggling to regain any traction," said Millan Mulraine, deputy chief economist at TD Securities in New York.
Industrial production fell 0.6 percent after edging up 0.1 percent in February, the Fed said. March's decline was the largest since August 2012 and was worse than economists' expectations for only a 0.3 percent drop.
A 17.7 percent plunge in oil and gas well drilling pulled mining production down 0.7 percent in March, marking the third straight month of declines in mining output.
Crude oil has lost more than half of its value since last June, resulting in a sharp drop in well drilling activity. Companies in the oil field are also either postponing or cutting back on capital expenditure projects.
Separately, the Fed in its Beige Book report of anecdotal information on business activity collected from contacts nationwide said investment in oil and gas drilling had declined and related layoffs were reported by "multiple" regions.
Caterpillar Inc (NYSE:CAT) early this year cut its 2015 profit outlook and warned lower oil prices would hurt its energy equipment business.
Last month, utilities production tumbled 5.9 percent, also weighing on industrial production.
"We do not see the emerging picture as supporting the hand of those who have been arguing for an earlier Fed rate hike," said Anthony Karydakis, chief economic strategist at Miller Tabak in New York.
Most economists have pushed back their expectations for the first rate hike to either September or October from June. Others believe monetary policy will only be tightened in 2016. The Fed has kept interest rates near zero since December 2008.
Data including for retail sales, housing starts, inventories, trade and manufacturing suggest the economy grew at a sub-1.5 percent annual rate in the first quarter after a 2.2 percent pace in the October-December quarter.
U.S. Treasury prices rose as the data supported bets the Fed was likely to wait longer to raise rates. Stocks rose while the dollar fell against a basket of currencies.
WEAK MANUFACTURING
For the first quarter, industrial production declined at an annual rate of 1.0 percent, the first quarterly decrease since the second quarter of 2009.
Oil and gas well drilling and servicing, which tumbled at a 69.8 percent rate, accounted for the bulk of the drop in industrial output in the first quarter.
While manufacturing output ticked up 0.1 percent in March, the first gain since last November, it fell at a 1.2 percent rate in the first quarter, the first decline since the second quarter of 2009.
The soft trend could persist for a while. In a separate report, the New York Fed said its Empire State general business conditions index fell to -1.19 in April from March's 6.90. This was the first negative read for the index since December.
The weakness in manufacturing, which accounts for about 12 percent of the economy, has been attributed to the buoyant dollar, bad weather and supply chain disruptions from the ports dispute.
Softer growth in Europe and Asia, especially China where the economy expanded at its slowest pace in six years in the first quarter, has also been a drag.
The dollar has gained 13 percent against the United States' main trading partners since last June, which economists say is equivalent to a 0.5 percentage point interest rate hike.
"The dollar's strength may be taking some of the oomph out of factory production, which had been on a tear until December last year," said Chris Rupkey, chief financial economist at
MUFG Union Bank in New York.
"Time will tell whether this is real weakness or simply a bump on the road to prosperity. Our guess remains the economy comes back strong later on this spring."
Companies like Microsoft Corp (NASDAQ:MSFT) and Procter & Gamble Co, the world's largest household products maker, and healthcare conglomerate Johnson & Johnson (NYSE:JNJ) have warned the dollar will hit sales and profits this year.