U.S. manufacturing sector contracts, prices decline in December

WASHINGTON, Jan 4 (Reuters) - U.S. manufacturing contracted further in December, but weakening demand amid higher borrowing costs pushed a measure of prices paid by factories for inputs to the lowest level in more than 2-1/2 years, signaling that goods disinflation was underway.

The Institute for Supply Management (ISM) said on Wednesday that its manufacturing PMI dropped to 48.4 last month from 49.0 in November, contracting for a second straight month.

That was the weakest reading since May 2020, when the economy was slammed by the first wave of COVID-19 cases, and pushed the index just below the 48.7 level, which the ISM says is consistent with a recession in the broader economy.

But with the labor market still pumping out jobs at a solid clip and sustaining consumer spending, it is unlikely that the economy is in recession. A PMI reading below 50 indicates contraction in manufacturing, which accounts for 11.3% of the U.S. economy. Economists polled by Reuters had forecast the index slipping to 48.5.

The Federal Reserve's fastest interest rate-hiking cycle since the 1980s as it battles inflation is dampening demand for goods, which are typically bought on credit. Americans are also shifting spending away from goods to services as the nation moves to a post-pandemic era.

The ISM survey's forward-looking new orders sub-index tumbled to 45.2, the lowest reading since May 2020, from 47.2 in November. It was the fourth straight month that this measure has contracted. Unfinished work has virtually dried up, a function of both weakening demand and improved supply chains.

The survey's measure of supplier deliveries fell to 45.1 from 47.2 in November. It declined below the 50 threshold in October for the first time since February 2016. A reading below 50 indicates faster deliveries to factories.

Fed officials and economists have always viewed supply chains, which were stretched early in the pandemic, as key to bringing inflation down to its 2% target. The significant improvement in supply as well as waning demand are already translating into monthly price decreases for goods. On a year-on-year basis, goods price increases have slowed considerably. Economists expect goods deflation this year.

The ISM survey's measure of prices paid by manufacturers dropped to 39.4 from 43.0 in November. Outside the plunge in April 2020, this was the lowest reading since February 2016 and marked the ninth straight monthly decrease in the index.

The ISM survey's measure of factory employment rebounded to 51.4 from 48.4 in November. This gauge, which has swung up and down, has not been a good predictor of manufacturing payrolls in the government's closely watched employment report.

According to a Reuters survey of economists, manufacturing employment likely increased by 9,000 jobs in December after rising 14,000 in November. Overall, nonfarm payrolls are forecast to have increased by 200,000 last month. The economy added 263,000 jobs in November.

The government is scheduled to release December's employment report on Friday.

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