U.S. industrial output fell to its lowest level in almost seven years in February and manufacturing in New York state slumped further this month, according to data on Monday that pointed to a worsening economy.

Adding to economy's problems, the U.S. Treasury said foreigners were net sellers of U.S. securities in January, a worrying development at a time when the government is rolling out a massive spending plan to break a 14-month recession.

The Federal Reserve said industrial production fell 1.4 percent, following a drop of 1.9 percent the prior month and worse than market expectations for a 1.1 percent decline.

Compared to the same period a year ago, output declined 11.2 percent with the index now at 99.7, the lowest level since April 2002, the central bank said.

Despite the poor data, U.S. stocks were on a firm footing as they extended their recovery from 12-year lows hit earlier this month, boosted by optimism that some stability might be returning to the financial sector.

Government bond prices fell, losing some of their safe-haven allure as equities rebounded, and the U.S. dollar dropped against the euro as investors took a dim view of the capital outflows in January.

The stock market is looking for an end to this credit meltdown and recession and it is going to see it presumably well in advance of the data actually turning, said Jay Mueller, senior portfolio manager at Wells Capital Management in Menominee Falls, Wisconsin.

I continue to expect to see some unpleasant economic numbers going forward.

Industrial capacity utilization dropped to 70.9 February, matching a December 1982 record low for the series which dates back to 1967, from 71.9 in January, the Fed said.

Manufacturing eased 0.7 percent in February after sliding 2.7 percent in January. The pace of decline slowed thanks to an increase in the production of motor vehicles and parts after extended plant shutdowns in January, the Fed said.

DOWNWARD ACCELERATION

The key is still the acceleration downward. The important thing to keep in mind is that producers are chasing sales downward to stabilize inventory, which is still overbuilt, said Christopher Low, chief economist at FTN Financial in New York.

The question is whether inventory is going fall enough to help GDP. We could see more production cuts in the second quarter.

Separately, manufacturing activity in New York State slumped in March as gauges tracking new orders and investments deteriorated. The New York Federal Reserve said its Empire State factory index, which dates back to July 2001, fell to yet another record low in March to minus 38.23 from February's minus 34.65.

One silver lining in the report was the six-month expectations gauge of business conditions, which bounced back into positive territory. But this was coupled with more signs that tight credit conditions were hampering business.

The report said its new orders and shipments indexes also dropped sharply to record lows. Investment was suffering as well, with gauges for expectations of capital spending and technology spending also falling to their weakest on record.

There was more bad news for the economy entangled in a recession since December 2007. The Treasury Department said net overall capital outflows from the United States were a record $148.9 billion in January.

The outflow, which includes short-term securities such as Treasury bills, fell well short of covering that month's $36.03 billion trade deficit. Demand for long-maturity securities like bonds, notes and equities shifted from an inflow in December.

This comes as the government rolls out a $787 billion stimulus plan to halt the economy's downward spiral.

But there was some comfort as China and Japan, the largest holders of U.S. securities, increased their Treasury holdings.

The reluctance of foreign investors to buy U.S. assets is a concern for the dollar going forward, said Matthew Strauss, senior currency strategist, at RBC Capital Markets in Toronto.

(Additional reporting by Burton Frierson, Richard Leong and Nick Olivari in New York, Editing by Chizu Nomiyama)

Manufacturing