By Lucia Mutikani
WASHINGTON (Reuters) - U.S. manufacturing contracted for a third straight month in June as demand remained subdued, while a drop in a measure of prices paid by factories for inputs to a six-month low suggested that inflation could continue to subside.
The weakness at the end of the second quarter reported by the Institute for Supply Management on Monday was across the board, with ISM Manufacturing Business Survey Committee Chair Timothy Fiore describing manufacturers as demonstrating "an unwillingness to invest in capital and inventory due to current monetary policy and other conditions."
Manufacturing is being pressured by higher interest rates and softening demand for goods, though business investment has largely held up.
"We expect the manufacturing sector to remain weak over the next couple of quarters," said Oliver Allen, senior U.S. economist at Pantheon Macroeconomics. "The retreat in corporate bond yields since late last year ... seems to have provided some support to investment spending, but not enough to get manufacturing growing again. A much more significant loosening in financial conditions is required to change that."
The ISM's manufacturing PMI slipped to 48.5 last month from 48.7 in May. A PMI reading above 50 indicates growth in the manufacturing sector, which accounts for 10.3% of the economy. The PMI remains above the 42.5 level, which the ISM says over a period of time indicates an expansion of the overall economy.
Economists polled by Reuters had forecast the PMI climbing to 49.1. It has indicated contraction in manufacturing in 19 of the last 20 months. Sixty-two percent of manufacturing gross domestic product contracted, up from 55% in May.
The share of sector GDP registering a composite PMI at or below 45 — a good barometer of overall manufacturing weakness — jumped to 14% from 4% in the prior month.
Eight manufacturing industries, including primary metals and chemical products, reported growth. Machinery, transportation equipment, electrical equipment, appliances and components as well as computer and electronic products were among the nine industries that contracted.
Commentary from manufacturers was mostly downbeat. Makers of chemical products reported a "high volume of customer orders." Transportation equipment manufacturers, however, complained that "customers continue to cut orders with short notice, causing a ripple effect throughout lower-tier suppliers."
Makers of electrical equipment, appliances and components reported that "customers (were) ordering more to create buffer stocks, in case of future shortages. Manufacturers of fabricated metal products mentioned signs of weak demand, adding "we must work to reduce inventory levels."
Machinery manufacturers said "sales backlog is decreasing," and that they had "furloughed a portion of our workforce as a result." Makers of miscellaneous manufactured goods reported that the "level of production is lower due to decreased demand for products."
Stocks on Wall Street were trading higher. The dollar was little changed against a basket of currencies. U.S. Treasury prices fell.
WEAK ORDERS
Government data last week showed manufacturing contracted at a 4.3% annualized rate in the first quarter, with most of the decline coming from long-lasting manufactured goods.
The Federal Reserve has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range since last July. Financial markets expect the U.S. central bank to start its easing cycle in September, though policymakers recently adopted a more hawkish outlook. The Fed has hiked its policy rate by 525 basis points since 2022 to quell inflation.
The ISM survey's forward-looking new orders sub-index rose to a still-subdued 49.3 reading from 45.4 in May. Output at factories decreased for the first time since February. The production sub-index fell to 48.5 from 50.2 in May.
Inflation at the factory gate was much cooler. The survey's measure of prices paid by manufacturers dropped to 52.1, the lowest reading since December, from 57.0 in May.
Declining goods prices accounted for much of the unchanged reading in monthly inflation in May, and the decrease in input prices last month bodes well for the continued disinflationary trend in the broader economy.
That was reinforced by the fourth straight month of faster delivery performance of suppliers to manufacturers.
"The improvement in supply chains ought to be viewed favorably by the Fed in terms of rebalancing demand for and supply of goods," said Conrad DeQuadros, senior economic advisor at Brean Capital.
Factory employment slipped after briefly rebounding in May amid layoffs, attrition and hiring freezes.
The overall labor market is gradually cooling. The government is likely to report on Friday that nonfarm payrolls increased by 190,000 jobs in June after surging 272,000 in May, according to a Reuters survey of economists. The unemployment rate is forecast unchanged at 4.0%.
Higher borrowing costs are also chipping away at growth in the construction sector, which had been boosted by demand for new homes amid a shortage of previously owned houses for sale.
A separate report from the Commerce Department's Census Bureau on Monday showed construction spending dipped 0.1% in May after an upwardly revised 0.3% increase in April. Economists had forecast construction spending rebounding 0.2% after a previously reported 0.1% fall in April.
Investment in residential construction dropped 0.2% after surging 0.9% in April. While mortgage rates have retreated from May's lofty levels, housing supply has improved considerably as demand slackened, which could limit growth in new construction.
"The perpetuation of high-for-long interest rate policy boosted the benchmark 30-year fixed mortgage rate back above 7% this spring, and demand for housing appears to have softened in response across a range of measures," said Michael Hanson, an economist at JPMorgan. "We see a likely pullback in residential construction during the second half of this year."
(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)
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