(Adds manufacturing data, analyst comments, updates markets)
* Housing starts fall 6.8 percent in March
* Single-family starts drop 6.2 percent
* Building permits rise 3.6 percent
* Manufacturing output falls 0.4 percent in March
By Lucia Mutikani
WASHINGTON, April 18 (Reuters) - U.S. homebuilding fell in March after unseasonably mild weather buoyed activity in February and manufacturing output dropped for the first time in seven months, further indications that economic growth braked sharply in the first quarter.
Coming on the heels of data last week showing the second monthly decline in retail sales in March as well a decrease in consumer prices, Tuesday's dour reports could reduce prospects of a Federal Reserve interest rate increase in June.
"The economy seems to have hit a soft patch in the first quarter and Fed officials are likely to wait to see the rebound before raising rates again. The clouds from the outlook skies may not lift until late this summer," said Chris Rupkey, chief economist at MUFG Union Bank in New York.
Housing starts decreased 6.8 percent to a seasonally adjusted annual rate of 1.22 million units as the construction of single-family homes in the Midwest recorded its biggest decline in three years, the Commerce Department said.
Economists had forecast homebuilding falling to a 1.25 million-unit pace last month. Housing starts were up 9.2 percent compared to March 2016.
In a separate report, the Fed said manufacturing production dropped 0.4 percent in March, weighed down by a 3.0 percent decline in the output of motor vehicles and parts.
That was the first and biggest decline in factory production since last August. The return of cold temperatures, however, resulted in a record 8.6 percent surge in utilities output, helping to lift industrial production 0.5 percent last month.
Manufacturing output rose at a 2.7 percent annual rate in the first quarter as the sector, which accounts for about 12 percent of the U.S. economy, continues to recover after a prolonged drag from lower oil prices, a strong dollar and an inventory overhang.
Reports on consumer and construction spending as well as inventory investment suggest the economy slowed sharply in the first quarter after gross domestic product increased at a 2.1 percent annualized rate in the fourth quarter of 2016.
The Atlanta Fed is currently forecasting GDP rising at a 0.5 percent rate in the first three months of the year, which would be the weakest performance in three years. The Fed lifted its overnight interest rate by a quarter of a percentage point in March and has forecast two more increases this year.
Tuesday's weak reports combined with other factors to push the dollar to a nearly three-week low against a basket of currencies and lift prices for U.S. government bonds.
U.S. stocks were trading lower, also hurt by disappointing quarterly results from corporate heavyweights Goldman Sachs and Johnson & Johnson.
Last month's decline in homebuilding was likely payback after the warm weather pulled forward construction in February.
Single-family homebuilding, which accounts for the largest share of the residential housing market, fell 6.2 percent to an 821,000 unit pace last month, retreating from a near 9-1/2-year high. Single-family starts in the Midwest, which was lashed by a storm last month, declined 35 percent.
That was the largest drop since January 2014 and pushed starts to their lowest level since August 2015. Single-family building permits in the Midwest decreased 5.9 percent.
Single-family starts also fell 5.5 percent in the West and were unchanged in the Northeast. They rose 3.2 percent in the South. Last month, starts for the volatile multi-family housing segment dropped 7.9 percent to a 394,000 unit pace.
Still, housing remains on solid footing. Overall building permits increased 3.6 percent, driven by a 13.8 percent jump in the multi-family segment.
Though single-family permits fell 1.1 percent last month, they were not too far from the more than nine-year high reached in February. A tightening labor market, which is generating steady wage growth, is underpinning the housing market.
"Mild winter weather in the first two months of the year pushed construction forward," said Gus Faucher, chief economist at PNC Financial in Pittsburgh. "Homebuilding continues its gradual recovery."
The sector, however, remains constrained by a dearth of properties available for sale. Builders have failed to bridge the gap, citing a range of problems including shortages of labor and land as well as rising material prices.
Reporting By Lucia Mutikani; Editing by Andrea Ricci