(Adds federal budget report, graphic)
* Markit flash factory PMI falls to 52.5 in March
* Existing home sales surge in February
* Wholesale inventories rise in January
* U.S. budget deficit widens in February
By Jason Lange
WASHINGTON, March 22 (Reuters) - U.S. manufacturing activity unexpectedly cooled in March, a troubling sign for the economy although the housing market showed signs lower interest rates were giving it a boost.
Financial data firm Markit's purchasing managers index for U.S. manufacturing fell to 52.5 in March, its lowest level since June 2017. Both new orders and output softened.
Analysts polled by Reuters had expected the gauge to strengthen to 53.6 from 53.0 in February. Readings above 50 point to growth in the sector.
The slowdown in U.S. manufacturing is part of a global trend in which international trade tensions appear to be leaving their mark on factory output. Markit also released PMI reports showing factory activity contracted in the euro zone and in Japan.
The reports helped push the spread between three-month Treasury bills and 10-year note yields to invert for the first time since 2007. The inverted yield curve is widely understood to be a leading indicator of recession. U.S. stock prices also fell.
Already, signs of a global slowdown have played a significant role in the Federal Reserve's signaling in recent months that it will pause and possibly end its interest rate hiking cycle, which began in 2015.
Some economists are concerned the Fed may have already lifted rates too high. The U.S. housing market spent much of 2018 in a dismal state, held back by higher rates.
On Friday, however, a report from the National Association of Realtors showed U.S. home sales surged in February to their highest level since March 2018.
Existing home sales jumped 11.8 percent to a seasonally adjusted annual rate of 5.51 million units last month, the NAR said.
That was above analysts' expectations and could be a sign that the Fed's pause on rate hikes is helping home sales.
"Declines in mortgage rates are beginning to provide some support," economists at Oxford Economics said in a note to clients.
However, the U.S. economy is already slowing, partly due to the fading of a major fiscal stimulus in 2018.
The New York Federal Reserve said one of its forecasting models pointed to a 1.29 percent growth rate in the first quarter. That's well below the 2.9 percent growth clocked in 2018, which was just below U.S. President Donald Trump's 3 percent growth target.
If the U.S. were to fall into recession, some economists have argued that the federal government's giant budget deficit could limit its ability to support growth.
The federal government posted a $234 billion deficit in February, up from $215 billion a year earlier, the Treasury said in a monthly report. The fiscal situation has deteriorated following a large tax cut enacted in 2018, with the government running nearly $1 trillion into the red during the 12 months through February.
In another potential ding for the economic outlook, Commerce Department data showed U.S. wholesale inventories increased by the most in more than six years in January.
While that could boost the standard measure of economic growth during the first quarter, it could also be a sign that lackluster consumer purchases are leading goods to pile up on businesses' shelves.
"(This) points to some weakness in final demand," Barclays said in a note to clients.
Reporting by Jason Lange; Additional reporting by Paul Simao in Washington and Richard Leong in New York; editing by Andrea Ricci