DOW JONES INDUSTRIAL 
By 
By Lucia Mutikani
With consumer confidence remaining at depressed levels, the reports suggested the economy could take longer to pull out of a downturn that is on track to be the longest and possibly deepest since World War Two.
"We seem to be digging an economic hole of major proportion which will only add time to the turnaround," said Kevin Giddis, head of fixed-income sales, trading and research at Morgan Keegan in Memphis, Tennessee.
The Consumer Price Index dropped 0.7 percent in December, a third straight monthly decline, capping a year in which prices advanced only 0.1 percent -- the weakest 12-month reading since December 1954, the Labor Department said.
Weakening economic activity worldwide has depressed commodity prices, pulling headline inflation figures down sharply.
But core U.S. inflation, which strips out volatile food and energy costs, is also slowing, increasing the risk of deflation.
On Wall Street, markets were little moved by the data, which was overshadowed by an announcement overnight of more government aid to the Bank of America
U.S. Treasury debt prices slid and the dollar fell broadly amid worries about a huge supply overhang from government measures to stabilize the banking system and economy.
Analysts said the inflation report, coming on the heels of data on Thursday that showed a fifth straight decline in U.S. producer prices in December, marked the shift toward technical deflation in the headline CPI number.
"It just confirms that there is no inflation. We have to worry about deflation," said Robert MacIntosh, chief economist, Eaton Vance Corp in Boston. "The economy is weak enough that you can actually have falling core CPI for a little bit."
Deflation, which is a sustained decline in price levels, is regarded as dangerous because it stifles economic growth.
Mounting job losses, falling household wealth and tight credit conditions have forced consumers to hold back on spending, limiting businesses' ability to raise prices and encouraging some to offer heavy discounts to lure customers.
INDUSTRIAL OUTPUT SHRINKS
With U.S. consumers retrenching, industry is cutting back sharply. The Federal Reserve said on Friday that U.S. industrial production dropped 2 percent last month, capping a dismal year for manufacturing as the recession took hold.
For the fourth quarter, industrial output fell at an 11.5 percent annualized rate. Compared with December 2007, industrial production was down 7.8 percent, the biggest 12-month drop since September 1975.
Analysts said the data illustrated the urgent need for a massive fiscal injection to turn around the economy. President-elect Barack Obama and Congress are working on a package of spending and tax cut measures to stimulate demand.
"There is little hope of a near-term revival in manufacturing without a huge fiscal stimulus program implemented with a sense of urgency," said Roger Kubarych, an economist at Unicredit Markets and Investment Banking in New York.
Richmond Federal Reserve President Jeffrey Lacker said on Friday deflation was not a major threat at the moment.
But the Fed has slashed benchmark interest rates virtually to zero and with little firepower left on that front, is focused on pumping money into troubled credit markets to try to restart lending, hoping to spur activity and beat back incipient deflation risks.
Core prices, which exclude food and energy items, were flat for the second month in a row in December. On a year-over-year basis, core inflation rose 1.8 percent, the smallest increase since December 2003 and still within Fed officials comfort range.
Energy prices fell 8.3 percent in December, after declining 17 percent the prior month. Compared to the same period last year, energy prices were down a record 21.3 percent.
The gasoline index slid 17.2 percent and accounted for almost 90 percent of the decrease in headline CPI, the Labor Department said.
Falling gasoline prices have contributed to a small uptick in consumer confidence in January, but sentiment remained at comparatively depressed levels. The Reuters/University of Michigan Surveys of Consumers' preliminary index reading of confidence for January rose to 61.9 from December's 60.1.
Analysts were encouraged that average weekly earning rose for a second straight month in December on an annual basis, a trend they said could stimulate demand in the months ahead.
Average weekly earnings rose at an annual rate of 2.9 percent, extending an upward trend that started with November's 2.3 percent advance, after sliding since January.
"We're not suggesting there is going to be an immediate boost to spending as a result of these initial increases in real pay," aid Bernard Baumohl, chief global economist at the Economic Outlook Group, in Princeton New Jersey.
"(But) history has shown sustained increases in real earnings is an essential prerequisite to higher spending by households," he added.
(Additional reporting by Emily Kaiser in Washington and Chris Reese in New York; writing by Lucia Mutikani and Tim Ahmann; editing by Gary Crosse)
