Thursday, May 1, 2008

U.S. Economy: Manufacturing Shrinks for a Third Month (Update2)

By Bob Willis and Shobhana Chandra

May 1 (Bloomberg) -- Manufacturing in the U.S. shrank for a third month and rising prices eroded consumers' buying power as the six-year economic expansion ground to a halt.

The factory index compiled by the Tempe, Arizona-based Institute for Supply Management was unchanged at 48.6 in April. The Commerce Department said consumer spending rose 0.4 percent in March. Stripping out the effect of inflation, purchases were up 0.1 percent after stagnating the previous month.

The ISM report indicated no sign of improvement from the first quarter, when only a jump in inventories prevented the economy from shrinking. Consumers and manufacturers are struggling with rising prices and the worst housing slump in a quarter century. Home Depot Inc., the world's biggest home- improvement retailer, today scaled back expansion plans and said it will fire workers as its sales and earnings deteriorate.

``The economy is still in a mode where it's declining,'' Brian Bethune, director of financial economics at Global Insight Inc. in Lexington, Massachusetts, said in an interview with Bloomberg Radio. ``These numbers certainly reflect that. We're going to see weaker jobs numbers and we're going to see consumption bump along at a very slow rate.''

Treasuries reversed early gains after the ISM report, with the yield on 10-year notes rising to 3.77 percent at 4:27 p.m. from 3.73 percent late yesterday. The Standard & Poor's 500 stock index closed up 1.7 percent at 1,409.34.

Inflation Threat

Today's reports also showed that the Federal Reserve's preferred measure of consumer prices rose more than anticipated, and that manufacturers are paying the most for goods in four years. Fed policy makers yesterday signaled they are ready to pause their series of interest-rate cuts as some former officials warn about stoking price pressures.

``I really don't think the Fed should continue to cut,'' Susan Bies, a former Fed governor, said on Bloomberg Television yesterday. Given the inflation rate, ``the risk is it's taking away from people's spendable income.''

The ISM figure was higher than economists had forecast as exports continued to prevent a deeper decline in manufacturing. The median estimate among 78 projections in a Bloomberg News survey was 48. Fifty is the dividing line between contraction and expansion. Manufacturers account for 12 percent of the economy.

Today's spending data were incorporated in the Commerce Department's report on gross domestic product yesterday, which showed that consumer spending rose at a 1 percent annual pace last quarter, the weakest since the 2001 recession. GDP rose 0.6 percent in the period, the same as in the previous three months, marking the slowest six months of expansion in seven years.

Four-Year High

The Labor Department reported separately that first-time claims for unemployment insurance rose more than forecast last week, to 380,000. The total number of Americans receiving benefits climbed to 3.019 million, the highest level since April 2004.

``Consumers are struggling,'' said Ryan Sweet, an economist at Moody's in West Chester, Pennsylvania. ``Their finances are being squeezed on two fronts: they're getting pressure from higher energy prices and slower income and job growth.''

A report tomorrow is forecast to show payrolls shrank in April for a fourth month, which combined with record fuel prices and slumping home values, indicates spending may slow.

The Commerce Department also reported today that spending on U.S. construction projects fell 1.1 percent in March as homebuilding posted the biggest one-month drop on record.

Economists' Forecasts

Economists had forecast a spending gain of 0.2 percent, according to the median of 78 estimates in a Bloomberg News survey.

Incomes increased 0.3 percent, less than estimated, after a 0.5 percent gain in February. The median forecast for incomes called for a 0.4 percent increase.

Households spent mainly on services such as medical care and utilities, and bought fewer big-ticket items such as cars and furniture.

The inflation measure tracked by the Fed, which strips out food and fuel prices, increased 0.2 percent after a 0.1 percent gain the previous month. It rose 2.1 percent from March 2007, compared with a median estimate of 2 percent.

Policy makers yesterday cut the main interest rate by a quarter point to 2 percent, the seventh reduction since September. The Federal Open Market Committee removed language from its March statement that ``downside'' risks to growth remained, and said that ``substantial'' easing of policy to date should help spur growth over time.

Savings Rate

Because the increase in spending was bigger than the gain in incomes, the savings rate fell to 0.2 percent, from 0.4 percent the prior month. Disposable income, or the money left over after taxes, increased 0.3 percent.

Retail sales signal continued weakness. Sales at stores open at least a year rose 1.9 percent last week from a year earlier, the eighth straight week below 2 percent, according to the International Council of Shopping Centers and UBS Securities LLC.

The government this week started sending out tax rebate checks as part of the Bush administration's fiscal stimulus plan. Retailers are trying to lure shoppers to spend the extra cash.

Wal-Mart Stores Inc., the world's largest retailer, will cash tax-rebate checks for free and cut prices on shampoo, cereal and groceries.

`Very Hopeful'

``We see the strain on the consumer as they get near the end of the month,'' Jane Thompson, president of Wal-Mart's financial services, said in a phone interview this week. ``We're very hopeful for what this is going to do for the economy.''

Home Depot's planned job cuts are the third this year. The retailer employs about 331,000 people, two-thirds of them full- time.

The rebates may be more of a temporary relief for consumers burdened by gasoline prices approaching $4 a gallon and by three consecutive months of job losses.

``Growth may just manage to stay above the zero line yet again in the second quarter, thanks to the heavy-duty support from the rebates,'' Doug Porter, deputy chief economist at BMO Capital Markets in Toronto, said before the report. Still, ``much of the stimulative impact will be gobbled up by surging gasoline and food costs.''

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