October industrial output down

Output at factories, mines and utilities fell 0.5 percent last month, the biggest decline since a matching drop in January, the Federal Reserve report said on Friday.

Economists surveyed ahead of the report were expecting total output to increase 0.1 percent in October.

"Manufacturing was pretty weak ... suggesting that the factory sector is heading for recession, if not already in one," said Kenneth Kim, economist at Stone and McCarthy Associates.

Despite the weak economic news, financial markets pared expectations for future interest rate cuts as two Fed officials suggested they saw little need to move borrowing costs lower.

Treasury prices slipped on the comments by Fed Governor Randall Kroszner and St. Louis Fed Bank President William Poole. The dollar fell against the euro on the weak economic data while stocks were mostly flat in midmorning trading.

According to the Fed report, manufacturing output was down 0.4 percent after a 0.2 percent gain in September. That brought down capacity utilization to 81.7 percent from 82.2 percent, slightly below the 82 percent economists were expecting.

Motor vehicles and parts production was down 1 percent in October after a 3 percent drop in September.

"It was a broad-based drop in manufacturing activity," said Michael Moran, chief economist at Daiwa Securities America in New York. "If you look at the past several months, we're down on balance in the manufacturing sector so we're seeing some soft numbers in this area of the economy."

Separate Treasury Department data on Friday showed U.S. net capital outflows moderated in September as foreign purchases of long-term securities rebounded sharply from the previous month's sell-off.

The slowdown in the outflow came as international investors bought a net of $26.4 billion in long-term U.S. securities, after selling $70.6 billion in August.

This compared with economists' expectations for an inflow of $70 billion in September.

"The consensus was too high given the 3.8 percent drop in the dollar index in September. We are still a bearish U.S. dollar market," said David Watt, senior currency strategist at RBC Capital Markets in Toronto.

China, the second biggest holder of U.S. Treasuries, reduced its holdings to $396.7 billion versus $400.2 billion in August, the Treasury report showed.

(Additional reporting from Ellen Frielich and Lucia Mutikani in New York)

(Reporting By Joanne Morrison; Editing by Neil Stempleman )