Manufacturers shift into reverse

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NEW YORK (CNNMoney.com) -- Manufacturing activity unexpectedly declined for the first time in 11 months in December, a survey of purchasing managers in that sector released Wednesday showed.

The Institute of Supply Management's manufacturing index weakened to 47.7, compared to 50.8 in November. Economists surveyed by Briefing.com had expected the index to show slower growth forecasting a reading of 50.5.

The unexpected weakness in manufacturing came due to a sharp drop in new orders and production. The reading, one of the first looks at the economy in December, raised questions of whether more Federal Reserve rate cuts and possibly a recession were on the horizon.

The tipping point for the index is 50, with a reading above that reflecting growth in the sector. A reading below 50 represents a decline in manufacturing.

The report said slowing demand for products, rather than excess inventories, resulted in manufacturers hitting the brakes during the month.

"December was apparently a very tough month as new orders, production and employment were all below the breakeven mark of 50 percent," Norbert Ore, chairman of the ISM's Manufacturing Business Survey Committee said in a statement. "Industries close to the housing market appear to be struggling more than others, and those involved in exports seem to be doing better."

The overall reading of the index is the weakest since April 2003, and it also marks the sixth straight month that the index has dropped. It is another sign that the U.S. economy slowed significantly in the fourth quarter after showing resilience through the third quarter despite this summer's meltdown in mortgage and credit markets.

Wachovia economist Adam York said that even with the long trend of weaker growth, having the index fall below 50 was a surprise. Even with the reduced role of manufacturing in the nation's economy, repeated readings below 50 are a sign of trouble ahead, he said.

Still, he cautioned: "One month doesn't a trend make. We've touched those levels without it indicating a recession is coming."

The Fed did not cut interest rates when the ISM reading fell below 50 in November 2006 and again in January 2007. But York said with the Fed already having cut rates at its previous three meetings, this reading makes another rate cut at the end of January more likely.

"If nothing else, it gives them some cover to keep cutting rates," York said. "They don't have to keep preaching about fighting inflation as hard."

But Jeoff Hall, the chief U.S. economist for Thomson Financial, said he's not convinced that the Fed will need to respond to this report with more cuts, especially with the reduced role that manufacturing plays in the U.S. economy today compared with August 2000, when the ISM manufacturing started an 18-month streak with readings below 50, and was seen as a warning of the coming recession.

"Maybe I'm missing something, I'm not convinced this is the straw that will break the camel's back," he said. Still, even Hall said the sharp drop in orders and production was worthy of attention.

"We're trying to find some silver lining in some bad news, but the 800-pound gorilla here is the drop in production and orders," he said. "It's tough to overlook those."

The survey showed only 15 percent of executives reported stronger new orders in the month, down sharply from the 27 percent who reported an increase in November. The percent reporting a drop in the level of new orders rose to 30 percent from 27 percent previously. It was the weakest reading on new orders since May 2001, when the nation was in a recession.

The level of production also showed a sharp decline to the worst reading since March 2003. Those who reported an improved level of production at their company fell to 16 percent from 23 percent, while those who said there was a worse level of production rose to 26 percent from 23 percent.

With that drop in orders and production, the survey's employment reading also showed weakness, although that was little changed compared to the November result. Only 11 percent said they saw higher levels of staffing down from 14 percent, while the percent who saw lower staffing levels also edged lower to 18 percent from 19 percent.