U.S. factory activity slows; inflation pressures subside

News 01 May 2017
U.S. factory activity slows; inflation pressures subside

FILE PHOTO: An H&M store has sale signs in the window in New York City, U.S., August 11, 2016. REUTERS/Joe White By Lucia Mutikani | WASHINGTON

WASHINGTON U.S. factory activity slowed in April while consumer spending was unchanged in March and a key inflation measure recorded its first monthly drop since 2001, but economists still expect an interest rate increase in June as the labor market tightens.

The weak reports on Monday came ahead of the Federal Reserve's two-day policy meeting on Tuesday. The U.S. central bank is not expected to raise interest rates at the end of the meeting on Wednesday. The reports did little to change expectations of a rate hike in June.

"We don't expect that will prevent the Fed from hiking interest rates again at the June meeting, at least not as long as employment growth rebounds in April and May," said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.

The Institute for Supply Management (ISM) said its index of national factory activity dropped to a reading of 54.8 last month, the weakest reading since December, from 57.2 in March.

A reading above 50 indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy. The ISM index had risen since last November, scaling a 2-1/2-year high in February, amid optimism over President Donald Trump's pro-business policy proposals.

It has declined in the last two months and some economists say the retreat probably reflects caution among business as they await implementation of the proposals. The Trump administration last week proposed a tax plan that includes cutting the corporate income tax rate to 15 percent from 35 percent, but offered no details.

The manufacturing recovery is being supported by the energy sector as steady increases in crude oil prices boost drilling activity. The government reported on Friday that spending on mining exploration, wells and shafts surged at a record rate of 449 percent in the first quarter.

Last month, the ISM survey's new orders sub-index fell to its lowest level since November and a measure of factory employment fell to a six-month low.

Prices for U.S. government bonds were trading lower, while the dollar was marginally lower. U.S. stocks were little changed.

MONTHLY INFLATION FALLS

The Fed lifted its overnight interest rate by a quarter of a percentage point in March and has forecast two more hikes this year. The consumer spending data was included in last Friday's first-quarter gross domestic product report, which showed consumer spending increasing at a 0.3 percent annual rate – the slowest pace since the fourth quarter of 2009.

Consumer spending accounts for more than two-thirds of U.S. economic activity. The economy grew at a 0.7 percent rate in the first quarter, the worst performance in three years.

The personal consumption expenditures (PCE) price index excluding food and energy slipped 0.1 percent, the first and largest drop since September 2001, after increasing 0.2 percent in February. In the 12 months through March, the so-called core PCE price index increased 1.6 percent, the smallest gain since last July, after advancing 1.8 percent in February.

The core PCE is the Fed's preferred inflation

measure. The U.S. central bank has a 2 percent target.

"We view the drop in the core PCE price index in March as an aberration and we expect the core inflation rate to creep upwards over the coming months," said John Ryding, chief economist at RDQ Economics in New York.

The overall PCE price index fell 0.2 percent in March. That was the first decline since February 2016 and the biggest drop since January 2015. In the 12 months through March the PCE price index increased 1.8 percent after rising 2.1 percent in February.

With price pressures subsiding, inflation-adjusted consumer spending increased 0.3 percent in March, ending two straight months of decline. March's increase in real consumer spending sets it up for an acceleration in the second quarter.

Consumption will likely be supported by a pick-up in wage growth. A report on Friday showed private sector wages recorded their biggest increase in 10 years in the first quarter.

Overall consumer spending in March was constrained by a 0.7 percent drop in purchases of long-lasting goods such as automobiles. A cold snap boosted demand for heating, lifting spending on services by 0.4 percent.

Personal income gained 0.2 percent in March after rising 0.3 percent in February. Income at the disposal of households

after accounting for inflation increased 0.5 percent, the biggest gain since December 2015. Savings increased to a one-year high of $849.1 billion from $819.0 billion in February.

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

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