US manufacturing shrinks for first time in 3 years

US manufacturing shrinks for first time in 3 years
By Daniel Pimlott and Michael Mackenzie in New York
Copyright The Financial Times Limited 2006
Published: December 1 2006 16:00 | Last updated: December 1 2006 16:00



The US manufacturing industry contracted last month for the first time in over three years suggesting that weakness in the economy has spread beyond the housing market, according to a closely watched measure of industrial activity.

The Institute for Supply Management said its index of activity in US factories fell in November to 49.5 per cent, down from 51.2 last month and below forecasts of 51.5.

Falling below the 50 per cent level is an indication of contraction, and is considered significant because signs of decline in manufacturing have traditionally over the last 20 years spurred the Federal Reserve to cut interest rates.

Rates have been held at 5.25 per cent since August, following 17 consecutive rises.

The market was pricing in a 80 per cent chance of a quarter point rate cut by the end of March, against 50 per cent before the release of the data.

The ISM data come after Chicago manufacturing data on Thursday showed industry was contracting in the midwest, also coming in below expectations.

“If we were running the Fed, we’d ease today, but the agony will probably be drawn out a couple more meetings while the backward-looking contingent are finally persuaded to stop worrying about inflation; we expect the first ease in March,” said Ian Shepherdson, chief US economist at High Frequency Economics.

But a rapid interest rate cut may be less significant than in the past because manufacturing is a less important part of the US economy than it once was. Moreover, the prices paid component of the ISM, an indication of inflationary pressures, rose to 53.5 from 47.0 last month, potentially placing policymakers in a difficult position.

Other analysts suggested that the economy remained strong in most areas, and said that given the Fed’s recent warnings on inflation, an interest rate cut in the short term remained unlikely.

“The weakness is concentrated in the housing and auto-related sectors while most everything else still looks OK,” said Stephen Stanley of RBS Greenwich Capital.

He added: “We are simply not convinced that the economy is weak enough in a broad sense for the Fed to envision easing, especially given the levels of core inflation and the unemployment rate.”

The Fed’s interest rate setting committee has said it remains very concerned about inflation. In a speech earlier this week, Ben Bernanke, Fed Chairman, said inflation was still “uncomfortably high”.

The dollar weakened against the euro and the pound on news of the report, continuing the downward trajectory. Yields on two-year Treasury notes fell to 11 basis points to 4.50, outpacing a decline of five basis points on the 10-year note