Manufacturing in the New York area contracted for the third straight month in August, data showed on Monday, tempering any lingering hopes for a rebound in the U.S. economy in the second half of the year.

Manufacturing led the U.S. recovery in the past couple of years, even though it represents only about 12 percent of overall national output, but in recent months growth in the sector has slowed sharply.

The New York Federal Reserve's Empire State index showed the general business conditions index fell to minus 7.72 in August from minus 3.76 the month before. Economists polled by Reuters had expected a reading of zero.

This is consistent with the negative tone that has permeated throughout the markets. Clearly we are not starting the new round of manufacturing data on good footing, said Tom Porcelli, chief U.S. economist at RBC Capital Markets.

The deterioration in the survey of manufacturing plants in New York state, the nation's third largest economy and the 14th biggest globally after Australia, bodes ill for the more widely followed Philadelphia Federal Reserve business conditions index due out on Thursday. This in turn can be a harbinger for the larger national survey from the Institute for Supply Management at the beginning of September.

Separate data on Monday showed the housing sector remained weak with a gauge of homebuilder sentiment stuck at historic lows and as Lowe's Cos Inc cut its fiscal-year outlook.

The Fed also said demand for consumer bank loans was largely flat over the past three months, while commercial and industrial lending saw some increased demand.

Atlanta Fed President Dennis Lockhart said risks of recession have risen over the last few months though he expected the economy could avoid an outright recession. [ID:nW1E7IR00Y].

Analysts said the New York report is cause for concern.

It certainly set a negative tone for the national ISM release that has been teetering at that breakeven point, said Lindsey Piegza, economist at FTN Financial in New York.

The ISM national factory activity index has dropped since peaking in February and just barely grew in July. The other major regional indexes have also shown a slower pace of growth, though New York has seen the most prolonged contraction.

While this is just the first of regional indicators, it does a fairly good job of predicting what the others will do, said Millan Mulraine, senior U.S. macroeconomic strategist at TD Securities.

We're still somewhat far off from getting into a double dip recession, but it suggests sluggish growth for the next quarter, he added.

New orders in the state, whose businesses include manufacturers of industrial metals and capital equipment, fell to their lowest level since November 2010, slipping to minus 7.82 from minus 5.45.

But employment showed some improvement. The index for the number of employees inched up to 3.26 from 1.11 and the average employee work week index rose to minus 2.17 from minus 15.56.

Prices paid eased, falling to 28.26 from 43.33. The index was also at its lowest level since November 2010.

The outlook for the months to come also deteriorated, falling to the lowest since February 2009. The index of business conditions six months ahead dropped to 8.70 from 32.22.

Financial markets paid little attention to the day's economic data. By late afternoon, U.S. stocks were more than 1 percent higher coming back from last week's wild swings on bargain hunting, U.S. deal news and speculation European leaders may get control of the region's debt problems.

HOUSING HEADWINDS

Separate data also showed U.S. homebuilder sentiment was unchanged at a low level in August, as a glut of distressed homes, tight credit, and economic uncertainty kept new buyers out of the market.

The NAHB/Wells Fargo Housing Market index held at 15 in August, on target with economists' expectations. It has hovered at historic lows between 14 and 22 since the start of 2008.

Readings below 50 mean more builders view market conditions as poor than favorable.

Homebuilder sentiment is likely to remain subdued in the near term, with residential construction constrained by the elevated level of foreclosed properties on the market, Michael Gapen, senior U.S. economist at Barclays Capital, wrote in a note.

Lowe's, the U.S.'s second largest home improvement retailer, reported weaker-than-expected quarterly sales and cut its fiscal-year outlook for the second time in three months as homeowners put off big renovations in an anemic economy.

Many U.S. homeowners have been hesitant to spend on expensive projects as housing prices fall and the economy shows few signs of a stable recovery.

In other data on Monday, foreigners unloaded U.S. assets in June for a second straight month and were net sellers of Treasuries for the first time in more than two years as a rancorous political debate over the nation's debt raised concerns about U.S. credit quality.

Treasuries suffered a net outflow of $4.5 billion, the first since May 2009, but China, the largest foreign U.S. creditor, increased Treasury holdings by $5.7 billion to $1.166 trillion.

(Reporting by Leah Schnurr; Additional reporting by Richard Leong and Alexandra Alper, Editing by Chizu Nomiyama)

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