Weak US output, job market point to recession

United States - * Industrial production posts biggest drop in 34 years

* CPI flat in September, core price gauge mild

* Jobless claims drop; 4-week average, continued claims up

* Mid-Atlantic factory index falls to 18-year low (Updates with industrial production)

WASHINGTON (Reuters) - U.S. industrial production posted the biggest monthly decline since 1974 while consumer prices were flat in September, according to reports Thursday that built a compelling argument for more interest rate cuts to slow a steep economic slide.

Adding to the gloom, a survey of Mid-Atlantic factory activity in October plummeted to its lowest in 18 years.

Industrial production tumbled 2.8 percent last month, the Federal Reserve said, far worse than the 0.8 percent decline that economists had expected. Business equipment production dropped 7 percent, a sign that companies were retrenching as the credit crisis intensified.

"Over the last three months, production is down 5.8 percent and is consistent with a recession," John Silvia, chief economist at Wachovia Corp (nyse: WB - news - people ), said in a note to clients.

Falling energy costs helped keep the Consumer Price Index steady, compared to forecasts for a 0.1 percent rise, Labor Department data showed. A separate Labor Department report on claims for jobless benefits indicated employers were trimming payrolls as profits shrink.

A survey of Mid-Atlantic factories reinforced the reports of falling industrial output and rising unemployment.

The Philadelphia Federal Reserve Bank said its business activity index slumped to -37.5 in October, the lowest reading since October 1990, from 3.8 in September. The survey's employment index was the lowest since December 2001 and the index of new orders hit the lowest since 1980.

The factory survey erased a higher open for U.S. stocks, a day after their worst session since the 1987 crash. Prices for U.S. government bonds, which generally rise in times of economic gloom, erased most of their early losses.

Economists said signs of moderating inflation and a soft job market give the Federal Reserve room to cut interest rates further to boost the flagging economy.

"With companies cutting back ... the outlook for payrolls and the unemployment rate is terrible," said Ian Shepherdson, chief economist for High Frequency Economics in Valhalla, New York. "Even with the banking crisis easing, the Fed will be under pressure from the ... data to keep cutting rates."

INDUSTRIAL WEAKNESS OVERSTATED

The Fed said Hurricanes Gustav and Ike, as well as a strike at aircraft maker Boeing (nyse: BA - news - people ), "severely curtailed" industrial production last month.

On the inflation front, so-called core prices, which exclude volatile food and energy costs, were also milder than expected, gaining 0.1 percent. Economists had expected a 0.2 percent gain.

Energy costs declined 1.9 percent in September after a 3.1 percent drop the previous month. Energy services prices, which include costs for natural gas and electricity, tumbled by 3.2 percent, the biggest decline in the 61-year history of the data series.

Gasoline prices fell by 0.6 percent after a 4.2 percent fall in August.

The Labor Department's report on claims for state unemployment insurance showed first-time filing fell 16,000 last week, but a spokesman for the department said a federal holiday on Monday may have skewed the jobless claims data.

In addition, a four-week moving average that smooths week-to-week volatility hit its highest level since October 2001 in the aftermath of the Sept. 11 attacks, underscoring a weakening labor-market trend.

The number of people remaining on the benefits roll after drawing an initial week of aid in week ended Oct. 4 rose 40,000 to 3.71 million, the highest level since June 2003.