A Federal Reserve report Wednesday found economic activity was relatively flat at the start of the year and businesses are pessimistic about growth in the months ahead. A separate Fed report showed U.S. industrial production slumped in December, led by weakness in manufacturing. A Labor Department report showed inflation was cooling.

Stocks fell Wednesday after the data releases. The S&P 500 shed 1.6%. The Dow Jones Industrial Average was down 1.8%, while the Nasdaq Composite Index lost 1.2%. The yield on the benchmark 10-year Treasury note declined 0.16 percentage point to 3.374%.

The latest data add to signs that the U.S. economy is slowing as the Fed pushes up interest rates to combat inflation. Hiring and wage growth eased in December, U.S. commerce with the rest of the world declined significantly in November, and existing-home sales have fallen for 10 straight months.

S&P Global downgraded its estimate for fourth-quarter economic growth Wednesday by a half percentage point to a 2.3% annual rate. Economists surveyed by The Wall Street Journal this month expect higher interest rates to tip the U.S. economy into a recession in the coming year.

“The lag impact of elevated inflation weighs heavily on U.S. households, it’s very clear that the median American consumer is still reeling from the loss of wages in inflation-adjusted terms,” said

Joseph Brusuelas,

chief economist at RSM US LLP. “We’re moving towards what I would expect to be a mild recession in 2023,” he added.

Federal Reserve Bank of St. Louis President

James Bullard

said Wednesday the central bank should keep on rapidly raising interest rates and supported a half-percentage-point increase at the Jan. 31-Feb. 1 meeting. 

“We want to err on the tighter side to make sure we get the disinflationary process to take hold in the economy,” he said at a Wall Street Journal Live event.

Mr. Bullard’s position is at odds with several of his colleagues, who have suggested that a slower pace of rate increases would be appropriate to allow Fed officials to gauge how their aggressive pace of policy tightening has affected the economy.

Inflation, while still historically high, is showing signs of cooling as demand eases. Unlike many government reports, retail sales aren’t adjusted for inflation. 

Consumer prices advanced 6.5% from a year earlier in December, the sixth straight month of deceleration. The producer-price index, which generally reflects supply conditions in the economy, fell in December from the prior month, and increased at the slowest annual pace since March 2021, the Labor Department said Wednesday.

The National Retail Federation said Wednesday holiday sales were disappointing. The trade group said November and December sales rose 5.3% compared with the same period last year to $936.3 billion. In November, the NRF said it expected holiday sales to rise between 6% and 8%. The NRF figures aren’t adjusted for inflation and exclude fuel, auto and restaurant spending.

Somewhat slower inflation at the end of the year didn’t offset weaker demand, said NRF Chief economist

Jack Kleinhenz.

 Consumers are “hit with higher food prices, they are getting hit with higher service prices and they are having to make choices,” he said. Some spending was likely pulled into October as retailers kicked off deals early this year, he added. Retailers discounted heavily and early to clear excess stock from their shelves and warehouses.

Zach Carney, of Boston, said he has been cutting back on eggs and red meat because the prices are so high. “The price of eggs really jumps out at you,” the 28-year-old publicist said. Instead, he has been stocking up on value packs of chicken and buying more store-brand cereal and olive oil, which cost less than national brands.

The retail sales report showed spending declined in a number of gift-giving categories in December, including at electronics, clothing and department stores, and with online retailers, a category which includes companies such as Amazon.com Inc.

Dining out at bars and restaurants dropped 0.9% in December. Sales of furniture and vehicles, which are sensitive to higher borrowing costs, both fell sharply. The only categories to post slight growth in December were grocery, sporting goods and home improvement stores, as winter storms battered many parts of the U.S.

Some retailers have said the recently completed holiday shopping season turned out to be weaker than expected. Macy’s Inc. warned of softer sales, and Lululemon Athletica Inc. said its profit margins were squeezed as shoppers bought more items on sale.

Many retailers had benefited from surging sales earlier in the pandemic as shoppers stocked up on everything from toilet paper to home electronics and furniture, supported by government stimulus dollars. Those tailwinds have cooled, leaving retailers and product manufactures to confront slower spending in some categories and the longer term dynamics of the industry, such as a gradual shift to online spending.

Apparel retailers are especially exposed to the current pullback in discretionary spending, said Kelly Pedersen, the U.S. retail leader at PwC, a consulting firm. “Buying fashion items at department stores is discretionary,” said Mr. Pedersen. Many apparel retailers are still working to sell through excess inventory and offering deep discounts amid weak demand, he said. 

Department stores, which saw a 6.6% sales drop in December, struggled to boost sales before the pandemic quickly shifted buying habits. In 2020, a string of department stores filed for bankruptcy, including Lord & Taylor, J.C. Penney Co., Neiman Marcus Group Ltd. and Stage Stores Inc. 

Party City Holdco Inc. filed for chapter 11 bankruptcy this week while noting inflationary pressures have hampered customers’ willingness to spend. Bed Bath & Beyond Inc. said this month it plans more layoffs and cost cuts amid falling sales.

The retail sales report offers a partial picture of consumer demand because it doesn’t include spending on many services such as travel, housing and utilities. The Commerce Department will release December household spending figures covering goods and services later this month.

Corporate reports out in February will add to that picture. Walmart Inc., Target Corp. and other large retailers—which sell a variety of goods such as food, clothes and décor—report quarterly earnings next month, which will include December sales.

—Suzanne Kapner and David Harrison contributed to this article.

Write to Harriet Torry at harriet.torry@wsj.com and Sarah Nassauer at Sarah.Nassauer@wsj.com