* Market awaits Fed policy decision due Wednesday
* Dec. Empire State manufacturing index weaker than forecast
* Nov industrial output posts largest gain in a year
* 5- and 7-year note auctions still ahead this week
NEW YORK, Dec 16 (Reuters) - U.S. Treasuries prices fell Monday following mixed manufacturing data as investors awaited a policy statement from the Federal Reserve later this week.
The New York Federal Reserve said on Monday its "Empire State" manufacturing activity index rose in December to 0.98 from -2.21 in November. Economists polled by Reuters had forecast a stronger reading of 4.8.
U.S. industrial production, however, recorded its largest increase in a year as mining and utilities output rebounded strongly, suggesting the economy is gaining steam as the year comes to an end.
Still, investors remained focused on what the Fed will say about its stimulus program on Wednesday, when it wraps up a two-day policy meeting. Many analysts expect a tapering announcement in the first quarter of next year, but say a move to rein in bond buying this week isn't off the table.
On the open market, benchmark 10-year Treasury notes fell 3/32 in price, leaving their yields at 2.877 percent. The 30-year bond fell 11/32 in price. Its yield rose to 3.894 percent.
Treasury markets have been a bit volatile in recent days due to lower volumes and uncertainty that the Fed could begin trimming bond purchases as soon as Wednesday. Analysts said low volume and unwinding of some curve flattening trades contributed to the afternoon selloff.
"It will surprise one way or the other, whether they do or don't taper," said Kim Rupert, managing director for global fixed income analysis at Action Economics in San Francisco. "I think that's what the jagged moves in Treasuries are all about."
A Reuters poll last week showed 32 economists forecast the U.S. central bank will act in March, while 22 said it would scale back its $85 billion monthly bond-buying program in January. Twelve economists expected a tapering announcement this week.
Recent data showing lower unemployment and improved economic indicators support an argument for the Fed to begin trimming its bond purchases, though a third element - lower inflation than the Fed wants - could prove a stumbling block. Fed policymakers have worried that meager price increases put the economy at risk of deflation, a phenomenon that tends to slow economic activity.
"That's part of what's caused this communication challenge with the Fed, that inflation is lower than when they first started talking about tapering," said Anthony Valeri, senior vice president and market strategist at LPL Financial in San Diego.
Short-dated issues stabilized after their yields broke above key support levels on Thursday, suggesting anxiety about how long the Fed will keep policy rates near zero after it stops buying bonds, currently at a monthly pace of $85 billion.
Dealers face a continued wave of supply this week: $35 billion in five-year debt ; $29 billion in seven-year notes ; and $16 billion in five-year Treasury Inflation-Protected Securities.