NEW YORK (CNN/Money) - Bonds settled slightly higher Tuesday following a rally earlier in the session that saw the yield on the benchmark 10-year note break briefly below a three-month low, as investors weighed a report on declining industrial output and shrugged off early signs of inflation.

The dollar also gained.

The benchmark 10-year note rose 3/32 of a point to 100 2/32 to yield 4.12 percent, down from 4.13 percent Monday. The 30-year bond gained 11/32 of a point to 113-21/32 to yield 4.47 percent, down from 4.48 percent in the previous session. Bond prices and yields move in opposite directions.

Prices for the five-year note added 2/32 of a point to 100 8/32, yielding 3.81 percent, and the two-year note remained unchanged to yield 3.60 percent.

The Federal Reserve said Tuesday that production from factories, mines and utilities unexpectedly dropped in April and businesses ran at a slower operating rate than in March.

The central bank said industrial production fell 0.2 percent last month, sharply contrary to Wall Street economists' forecasts that it would increase 0.2 percent.

The report, which sparked concerns of a manufacturing slowdown, outweighed an upbeat report that said housing starts surged 11 percent in April, to 2.04 million new units.

The rise in new home starts followed a plunge in the previous month of March, when housing starts plunged 17.6 percent. The March drop was the steepest in more than 14 years.

"Once again soft data appears to be generating more reaction in the bond market than strong data -- consistent with the bullish undertone," Alan Ruskin, research director at 4CAST, told Reuters.

The weak industrial report also overshadowed Producer Price Index figures which topped analysts' expectations. PPI -- a measurement of wholesale prices -- rose a sharp 0.6 percent in April, compared with a 0.7 percent rise in March, a government report showed Tuesday. Economists surveyed by Briefing.com had forecast a rise of 0.4 percent.

Analysts believe the report bolstered the case for the Federal Reserve to continue with its campaign of "measured" rate hikes.

While the PPI figure exceeded analysts' expectations, it wasn't enough to push down prices of U.S.-government backed debt, suggesting inflation worries are already priced into the market.

Investors may also be holding out from making big investments ahead of Consumer Price Index data set to be released Wednesday. CPI is generally less volatile than PPI and is a better indication of inflation. Economists surveyed by Briefing.com are looking for CPI to rise 0.4 percent in April after advancing 0.6 percent in March.

Higher inflation hurts bonds, as it erodes the value of the fixed-income investment. However, rising interest rates generally help the dollar, as they make dollar-denominated securities more attractive to foreign investors.

In currency trading, the dollar strengthened against the euro and yen.

The euro bought $1.2604, down from $1.2634 Monday, while the dollar bought ¥107.50, up from ¥106.86 the previous session.

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