(Industrial production article updated for prices, additional information.)

NEW YORK (

TheStreet

) -- Industrial production was unchanged in October, as increases in manufacturing and factory output were offset by a decrease in utilities production.

That disappointed market watchers, who were expecting industrial production to rise 0.3% after dropping 0.2% in September.

Production in manufacturing rose 0.5% in October, the strongest rise since July, led by an increase in durable goods output. Mining output dipped 0.1% while utilities production declined 3.4% as unseasonably warm temperatures reduced the demand for heating, the report said.

Within market groups, consumer foods output was unchanged. The output of business equipment spending rose 1.1%, the strongest since May. The production of construction supplies moved up 0.2 percent in October after having declined 0.4 percent in September. Materials output slipped 0.1%.

Manufacturing has been leading the recovery, buoyed by strong export demand as China and emerging markets continue to grow at a rapid pace.

However, the index of manufacturing sharply decelerated in the third quarter, as consumer demand in the U.S. started to weaken. After jumping 9.1% in the second quarter, factory output grew by a more modest 3.6% in the third quarter.

Capacity utilization came in at 74.8%, slightly below expectations of 74.9%. But the rate is still nearly 6% below its long-term average.

The substantial slack in production reserves, evident in the lower than average utilization rate, is of concern to the

Federal Reserve

. In a speech in October, Fed chairman Ben Bernanke said the slack in production was keeping cost pressures under check, resulting in

inflation levels that the central bank deemed too low.

While the market remains skeptical of QE2, there was further evidence to support the Fed's concerns on the economy. The Labor Department said early Tuesday

that prices at the wholesale level rose 0.4%, less than the 0.8% analysts were expecting. Excluding food and energy, prices actually dropped 0.6%.

The

SPDR Select Sector Utilities

(XLU) - Get Report

was down 1.3% in afternoon trading. The

SPDR Select Sector Industrials ETF

(XLI) - Get Report

was losing 1.7%.

-- Written by Shanthi Venkataraman in New York

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