By Lucia Mutikani

WASHINGTON (Reuters) – U.S. manufacturing slumped further in June, reaching levels last seen when the nation was reeling from the initial wave of the COVID-19 pandemic, but price pressures at the factory gate continued to deflate, a silver lining for the economy.

Shrinking activity left factories resorting to layoffs, the survey from the Institute for Supply Management (ISM) showed on Monday. ISM Manufacturing Business Survey Committee Chair Timothy Fiore described the practise as happening “to a greater extent than in prior months.”

At face value, the ISM survey is consistent with an economy that is in recession. But the so-called hard data such as nonfarm payrolls, first-time applications for unemployment benefits and housing starts, suggest the economy continues to grind along.

Risks of a downturn have, however, increased as businesses and consumers deal with the 500 basis points worth of interest rate increases from the Federal Reserve since March 2022, when the U.S. central bank embarked on its fastest monetary policy tightening campaign in more than 40 years.

“This provides further reason to suspect that a recession is on the horizon,” said Andrew Hunter, deputy chief U.S. economist at Capital Economics. “The ISM survey adds to the evidence that core goods prices will start falling again soon.”

The ISM’s manufacturing PMI dropped to 46.0 last month, the lowest reading since May 2020, from 46.9 in May. That marked the eighth straight month that the PMI stayed below the 50 threshold, which indicates contraction in manufacturing, the longest such stretch since the Great Recession.

Economists polled by Reuters had forecast the index edging up to 47. Manufacturing, which accounts for 11.1% of the economy, contracted at a 5.3% annualized rate in the first quarter, government data showed last week.

Some pockets of strength remain, however, amid solid demand for goods like transportation equipment.

The ISM survey showed that transportation equipment was the only one of the six biggest industries reporting growth last month. But even so, makers of transportation equipment expressed worries that second-quarter sales could decrease and boost inventory levels. They projected total end-of-year sales “to be about where we were last year.”

Apart from the exorbitant borrowing costs, manufacturing is also being undermined by spending shifting to services from goods, which are typically bought on credit. Businesses are also carefully managing inventories in anticipation of weak demand.

Economists say the sector has yet to feel the pain from a tightening in credit following financial market turmoil earlier this year.

In addition to transportation equipment, printing, nonmetallic mineral products and primary metals grew in June. The 11 industry groups contracting included wood products, textile mills, electrical equipment, appliances and components, machinery and computer and electronic products.

Stocks on Wall Street ended slightly higher in a shortened session ahead of Tuesday’s July 4 holiday. U.S. Treasury prices were mixed. The dollar was steady against a basket of currencies.

WEAK DEMAND

The ISM survey’s forward-looking new orders sub-index climbed to a still-subdued 45.6 from 42.6 in May amid increased caution from businesses and consumers alike.

“Inventory investment has become a drag on activity as factories become increasingly wary of excess stockbuilding,” said Jonathan Millar, a senior economist at Barclays in New York. “We continue to see ripening conditions for a downturn in hard data on factory production in the next few quarters.”

Computer and electronic products manufacturers said “customers are less inclined to purchase far in advance.” Manufacturers of food, beverage and tobacco products noted that “there is an elevated level of capital project review.”

Machinery manufacturers reported that “orders and business are steady with a healthy backlog, but new prospective orders seem to be getting pushed back into 2024.”

Weak demand is depressing prices for inputs. The survey’s measure of prices paid by manufacturers fell to 41.8 from 44.2 in May as bottlenecks in the supply chain have eased considerably and higher borrowing costs dampen demand.

The delivery performance of suppliers to manufacturing organizations has been faster for nine straight months, leading to goods disinflation. But services inflation, now the main focus, remains sticky because of stronger wage growth from a tight labor market, as well as higher rents for housing.

The survey’s gauge of factory employment fell to 48.1 from 51.4 in May. Though it is an unreliable predictor of manufacturing employment in the government’s nonfarm payrolls count, it aligns with expectations of slower hiring by year end.

The government is expected to report on Friday that payrolls increased by 225,000 jobs in June after rising by 339,000 in May, according to a Reuters survey of economists.

While manufacturing is deteriorating, housing appears to be reviving, thanks to a dearth of homes for sale.

A separate report from the Commerce Department on Monday showed spending on residential construction rebounded 2.2% in May after dropping 0.9% in the prior month, with investment in single-family housing projects accelerating 1.7%.

That contributed to boosting overall construction spending by 0.9% in May after gaining 0.4% in April.

“The residential segment has benefited from renewed demand while the inventory of existing homes for sale has remained low because homeowners have little incentive to sell in a weaker real estate market while assuming larger mortgage payments,” said José Torres, senior economist at Interactive Brokers in Miami.

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)

---