Manufacturing expands at slow pace

NEW YORK -- U.S. manufacturing expanded at a slower-than-expected rate in May, constrained by high energy prices and fat inventories, especially in the automobile sector, figures from a private research organization showed on Wednesday. Stock prices rose on speculation that the weak performance could give the Federal Reserve second thoughts about more interest rate hikes.

While manufacturing activity expanded in May for the 24th consecutive month, the rate has slowed in each of the last six months, and May's reading was the lowest since June 2003, according to the Institute for Supply Management.

In contrast, a separate report by the Commerce Department said construction spending rose 0.5 percent to a record level in April, as office construction surged and activity in the housing market hit an all-time high.

The Commerce Department said the increase pushed building activity to a seasonally adjusted annual rate of $1.066 trillion in April, following gains of 0.6 percent in March and 1.2 percent in February.

The Institute for Supply Management's manufacturing index stood at 51.4 in May, down from a reading of 53.3 the previous month and below analysts' expectations for a reading of 52. The index is at its lowest level since it was 50.4 in June 2003.

The data indicates that the manufacturing sector is losing momentum, the institute said. A reading of 50 or above in the index means the manufacturing sector is expanding, however. A figure below 50 represents a contraction.

The report drove the stock market higher as investors speculated that the weaker than expected performance of the industrial sector would make the Federal Reserve think twice before further tightening interest rates.

In late trading, the Dow Jones industrial average gained 43.30 to 10,510.78, although it have up some of gains as oil prices surged more than $2 per barrel. The Standard & Poor's 500 index added 6.27 to 1,197.77, while the Nasdaq composite index climbed 10.98 to 2,079.20.

"The data shows that the economy has cooled off," said Gary Thayer, chief economist at A.G. Edwards & Sons. Inc.

Thayer said that last year when the economy was stronger industrial companies pumped up their inventory levels. However, now those companies have enough inventory and are in the process of selling off what they have. That is especially true in the auto sector, Thayer noted.

"Auto makers are a concern," he said. "Gas prices mean consumers are balking at buying gas guzzling SUVs."

However, Richard D. Rippe, chief economist at Prudential Equity Group, said that gas prices had moderated recently, which could help the industrial sector regain some of its momentum and help the overall economy.

"Energy prices are the biggest short-term risk (for the industrial sector and the overall economy)," Rippe said.

Rippe said high energy prices would prompt inflation, driving up costs for industrial producers while crimping consumer spending.

The growth rate for new orders was slower in May than it was in April, the institute said. The new orders index for May was 51.7, down from 53.7 in April. Twenty-four percent of the companies responding to the institute's survey said new orders were worse in May, up from 17 percent in April.

The institute's report is based on a monthly survey it sends to 350 companies in 20 sectors. Typically, 60 percent to 70 percent of companies respond, the institute said.

The institute's employment index contracted in May, ending 18 months of expansion, the institute said. The index registered 48.8 percent in May, compared to 52.3 percent in April.

Rippe noted that overall employment in the economy was improving, however. He said May's slower growth is mostly a reflection of companies working through inventory, a normal occurrence in the business cycle.

He said the increase in price growth dropped dramatically, signaling inflation is in check. The price index stood at 58 in May, down from 71 in April.