WASHINGTON—U.S. industrial output rose in March and a measure of industry slack diminished, signs of underlying strength in the economy as factories increased production of business equipment and autos.

Industrial production—including output at factories, mines and utilities—rose a seasonally adjusted 0.5% in March from the prior month, the Federal Reserve said Tuesday. That exceeded economists’ expectations for a 0.4% increase. February industrial production was revised to a 1% gain.

Capacity...