Manufacturing slows in June, construction spending up in May

WASHINGTON -- Manufacturing activity shrank last month for the first time in three years, raising concerns about the overall health of the economy and feeding fears of another disappointing report on job growth later this week.

A closely watched index of the nation's factories fell to 49.7% in June from 53.5% in May, according to a survey by the Institute of Supply Management. A reading below 50% generally indicates that the sector is contracting, while above 50% means expansion. Survey participants blamed the slowdown on the European financial crisis and economic downturn, and slowing growth in China.

Most worrisome: the index for new orders, the best barometer of future production, plunged to 47.8% from 60.1% — the largest one-month decline in a decade. Readings of production and exports also fell sharply, while employment was roughly unchanged.

"Uncertainty about the state of economic expansion just got ratcheted up a notch with this report," RDQ Economics said in a research note.

Paul Dales, senior U.S. economist of Capital Economics, said risks to his forecast that a government report on Friday will show 125,000 job gains in June "are clearly on the downside." Monthly job growth averaged about 250,000 from December through February before averaging less than 100,000 the past three months.

Manufacturing largely has driven the economic recovery and, until recently, seemed to defy other sluggish indicators, such as consumer spending and home sales. In the first quarter, industrial production grew at a 10% annual rate.

But that growth was likely artificially inflated by warm winter weather that pulled forward sales and production, especially in the auto industry, as consumers finally began to replace aging vehicles, says Daniel Meckstroth, chief economist for the Manufacturers Alliance for Productivity and Innovation (MAPI).

The sharp drop in factory activity in June largely reflected a temporary snap-back effect from the robust first quarter, Meckstroth says.

But other forces, he says, may dampen output at least through the rest of the year, especially the economic slowdown in many European nations, which is dampening exports and creating uncertainty that's causing businesses to pull back on investment.

Also, he says, many businesses in the first quarter continued to rebuild inventories that had been depleted after Japan's earthquake and tsunami early last year — a phenomenon that is largely played out.

Meckstroth expects industrial production growth to slow to a 3% annual rate the second half, down from 4.3% in 2011.

Seven sectors continued to grow last month, including fabric metals, appliances and machinery, according to the ISM report. But nine industries contracted, including apparel, chemicals and food, beverage and tobacco products.

Stocks, which had largely been flat when the market opened, fell immediately after the report was released at 10 a.m. ET. The Dow Jones industrial average dropped 56 points.

Manufacturers produced less in May than in April, the Federal Reserve said in June. Automakers cut back on output for the first time in six months. In June, manufacturing activity barely grew in the New York region and contracted sharply in the Philadelphia area, according to surveys by regional Federal Reserve banks. Factory output ticked up in Chicago but only after sliding for three months.

Consumers are less confident in the economy than they have been at any time all year, according to a measure of consumer sentiment released Friday. Worries about slowing job growth are outweighing the benefits of lower gas prices. A separate measure of consumer confidence, issued Tuesday, showed that confidence fell for the fourth straight month.

Overall hiring has slowed sharply this spring, raising concerns about the pace of the recovery. Employers added an average of only 73,000 jobs per month in April and May. That's much lower than the average of 226,000 added in the first three months of this year. The unemployment rate rose in May to 8.2% from 8.1%, the first increase in a year.

Slower job growth and falling confidence is weighing on consumers' willingness to spend. Americans cut back on purchases of autos and other long-lasting factory goods in May, the government said Friday.

U.S. exports of manufactured goods have also suffered as Europe's financial crisis has cut into demand in that region. And slowing growth in China, India and other emerging markets means that companies in Asia and Latin America are buying fewer American-made cranes, trucks and other heavy equipment.

There have been a few good signs recently.

U.S. factories received more orders for long-lasting manufactured goods in May, the government said last week, while also noting that a key measure of business investment plans rose.

And home sales are up from last year, with prices rising in most cities and homebuilders planning to break ground on more projects in the next 12 months. That should raise demand for manufactured goods such as appliances, building materials and furniture.

Still, the economy grew at a tepid annual rate of 1.9% in the January-March quarter. Residential construction added to growth. But many economists expect growth slowed in the April-June quarter. The Federal Reserve has cut its forecast for the year. It now expects growth of just 1.9% to 2.4% for 2012. That's half a percentage point lower than the range it estimated in April. The Fed also says unemployment won't fall much further this year than it has.

In a separate report, a surge in homebuilding pushed U.S. construction spending up by the largest amount in five months, the latest indication that the housing sector is slowly recovering.

Construction spending rose 0.9% in May, following a 0.6% rise in April, the Commerce Department reported Monday. It was the biggest percentage gain since December.

The May increase pushed spending to a seasonally adjusted annual rate of $830 billion. That is 11.3% above a 12-year low hit in February 2011. Still, the level of spending is roughly half of what economists consider to be healthy.

Residential construction rose 3% to an annual rate of $261.3 billion, further evidence that housing has finally started to mount a modest recovery.

Spending on nonresidential projects rose 0.4% in May to an annual rate of $299.1 billion, the third straight monthly gain. In May, spending on shopping centers, hotels and office buildings all saw gains.

Government construction projects fell 0.4% to an annual rate of $269.6 billion, the lowest level since November 2006. Spending at the state and local level fell 1% to $242.6 billion at an annual rate. Federal construction rose 5.6% to a rate of 427 billion.

Recent data suggest the housing market is gradually improving after struggling for the past five years.

Homebuilders started work on more single-family homes in May and requested the most permits to build homes and apartments in three and a half years. Completed sales of new and previously occupied homes were up in May from the same month last year. The number of people who signed contracts to buy homes rose in May to match the fastest pace in two years.

Home prices are rising in most markets. And mortgage rates have tumbled to the lowest levels on record, which has encouraged more buying.

One reason prices are rising is the supply of homes for sale remains extremely low. There were 145,000 new homes for sale in May. That's just 1,000 higher than in April, when the supply was the lowest on records dating back to 1963.

With the supply is thin and sales rising, builders can charge more. It also means there's room for more competition. Economists say that may explain why builders are laying plans for more homes and apartments over the next 12 months.

Still, while spending on homebuilding has risen, spending on government building projects has fallen. Governments at all levels have been struggling to deal with huge budget gaps caused by the recession.

Contributing: Wire reports