July 15 (Bloomberg) -- Industrial production shrank less than forecast and a New York regional factory gauge showed the smallest contraction in more than a year, signaling manufacturing is on the verge of stabilizing.

The 0.4 percent decrease in output at factories, mines and utilities in June was the smallest in eight months, Federal Reserve figures showed today in Washington. The New York Fed’s Empire Index rose to minus 0.6 in July from minus 9.4 the month before. The Commerce Department said separately consumer prices rose 0.7 percent last month, spurred by energy costs.

Today’s manufacturing figures, along with Intel Corp.’s forecast yesterday for stronger sales, reinforce projections for a halt to the deepest recession in half a century in the second part of the year. At the same time, analysts anticipate a limited recovery with little inflation as the share of American factory capacity in use dropped to a record low.

“We’ll go through a very gradual rebuild of production,” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina, who accurately forecast the drop in output. “There’s uncertainty about the strength of demand, credit restraints are still there, and we have a weak labor market. The fundamentals point to an economy that won’t just boom off the map,” and with no inflation pressures.

Treasuries, Stocks

Stocks advanced after Santa Clara, California-based Intel’s forecast beat analysts’ estimates, and the Standard & Poor’s 500 Index closed up 3 percent at 932.68 in New York. Treasuries dropped, sending yields on benchmark 10-year notes to 3.63 percent at 4:14 p.m. from 3.47 percent late yesterday.

During their meeting last month, most Fed officials judged the economy at risk to further shocks even as they rejected an expansion in asset purchases aimed at lowering borrowing costs, according to minutes of gathering issued today in Washington. The report also showed that policy makers were not sure what influence such purchases would have on the economy or inflation expectations.

Industrial production was forecast to fall 0.6 percent after a previously reported 1.1 percent drop in May, according to the median estimate of 73 economists surveyed by Bloomberg News. Projections ranged from a gain of 0.2 percent to a drop of 1.1 percent.

Worst Over

“Many do feel the worst is behind them,” said Randy Wolken, president of the Syracuse-based Manufacturers Association of Central New York which includes companies ranging from Lockheed Martin Corp. to Pepco Energy Services Inc. Companies are uncertain about the outlook, Wolken said. “You don’t know the bottom until it’s past you.”

Manufacturing accounts for about 12 percent of the $14 trillion U.S. economy, the world’s largest.

Capacity utilization, which measures the proportion of plants in use, decreased to 68 percent last month, the lowest level since records began in 1967.

U.S. factory output, which accounts for about four-fifths of industrial production, fell 0.6 percent after a 1.1 percent decrease the prior month. Motor vehicle and parts production slumped 2.6 percent after plunging 8.2 percent the prior month, the report said.

The auto industry may get a lift from the “cash for clunkers” bill that Congress passed in June, which gives consumers as much as $4,500 to trade in their old cars for more fuel-efficient vehicles.

Auto Rebound

Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York, is among those projecting carmakers will crank up production to meet the demand spurred by the program. A rebound in production will help pull the economy out of the recession, leading to economic growth of 3 percent in the second half of 2009, Maki said.

Ford Motor Co., the only major U.S. automaker to avoid bankruptcy, already said on June 29 that it’s boosting third- quarter North American production by 16 percent from a year earlier.

Makers of personal computers are boosting orders for chips in anticipation of increasing demand in the second half, Intel’s Chief Executive Officer Paul Otellini said. While businesses probably won’t start buying new PCs until next year, consumers in Asia -- especially China -- are leading the recovery, he said. Intel reported a 12 percent jump in second-quarter sales from the previous three months, the largest sequential increase since 1988.

Orders Grow

The New York Fed’s Empire State report, one of the first regional factory measures of the month, showed the largest gain in orders since the recession began in December 2007.

“You’re seeing evidence that manufacturing is turning” across the country, said Zach Pandl, an economist at Nomura Securities International Inc. in New York.

Inflation will probably be restrained even as the economy improves because of rising unemployment and plenty of spare capacity to produce more without developing bottlenecks, economists said.

The Labor Department’s figures showed consumer prices were down 1.4 percent from June 2008, the biggest drop since January 1950.

Excluding food and energy costs, the so-called core index rose 0.2 percent last month. The gain over the last 12 months slowed to 1.7 percent from 1.8 percent in the year ended in May.

Declines in consumer spending and business investment are forcing companies to boost incentives or keep a lid on prices in order to move merchandise, and preventing them from passing higher energy costs on to customers. A surge in gasoline costs in recent months is now abating, indicating inflation may moderate as the year progresses.

“The risks are still to the downside” for prices, said Rudy Narvas, an economist at 4Cast Inc. in New York, who correctly forecast the increase in core prices. “Energy prices have come off. At the same time, we have an incredible amount of slack in the labor market -- and, with wage growth not there, pressure on prices will be” low, he said.

To contact the reporters on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net; Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: July 15, 2009 16:24 EDT