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 is in stark contrast with upbeat data on retail sales, employment, consumer and small business confidence, which have pointed to a pick-up in growth after a sluggish start to the second quarter.
"Production is under pressure from low oil prices, affecting mining, and the strong dollar, affecting manufacturing. Looking ahead, production is likely to stabilize when the oil industry regains its feet," said Chris Low, chief economist at FTN Financial in New York.
Industrial output slipped 0.2% last month after declining 0.5% in April, the Federal Reserve said on Monday. Industrial production has been weak since December and economists had expected output to rise 0.2% last month.
The weak industrial production data was likely to get the attention of Fed officials at their policy meeting on Tuesday and Wednesday, economist said.
While the U.S. central bank's policy-setting committee is not expected to raise interest rates at this week's meeting, it is likely to tighten monetary policy later this year.
Industrial production last month was held down by a 0.2% drop in manufacturing output. Manufacturing has been whacked by dollar strength, which has eroded profits of multinational corporations.
Companies like Microsoft Corp and Procter & Gamble Co, the world's largest household products maker, and healthcare conglomerate Johnson & Johnson have warned the dollar will hit sales and profits this year.
The dollar has gained about 13.2% against the currencies of the United States' main trading partners since last June.
U.S. financial markets were little moved by the data as investors kept a wary eye on Greece, which inched closer to defaulting on its debt. The dollar rose against a basket of currencies, while stocks on Wall Street fell. Prices for U.S. Treasury debt rose.
While motor vehicle production increased solidly last month and machinery, and computer and electronic products rose, that was insufficient 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% of the U.S. economy, was also weighed down by declining production 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 fell 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. While 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% to 3.0% annualized over the rest of this year."
GDP contracted in the first quarter, slammed by bad weather, port disruptions, the dollar and energy spending cuts.
Last month, mining production fell 0.3% as oil and gas well drilling and servicing fell 7.9%. That took the cumulative drop since the end of 2014 to 51.8%. 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, the world's No. 1 oilfield services provider, and Halliburton have slashed their capital spending budgets for this year. Caterpillar Inc has cut its 2015 profit outlook and warned that lower oil prices would hurt its energy equipment business.
Oil and gas production, however, increased 0.5% in May. Unseasonably warm weather in May lifted demand for air conditioning. Utilities production increased 0.2% after dropping 3.7% in April.
Industrial capacity use fell to 78.1% last month, the lowest since January 2014, from 78.3% in April.
Officials at the Fed tend to look at capacity use as a signal of how much "slack" remains in the economy and how much room there is for growth to accelerate before it becomes inflationary.