updated 9/4/2007 12:57:47 PM ET 2007-09-04T16:57:47

Growth in the manufacturing sector slowed in August while construction spending dropped sharply in July, indicating turmoil in the housing and financial markets could be spilling over to the broader economy.

Major Market Indices

One bright spot for the U.S. economy, however, has been the manufacturing sector’s exports, whose growth accelerated last month, but analysts are unsure whether that will be enough to offset housing-related woes that have hurt consumer sentiment.

The stock markets reacted positively, as investors decided that several aspects of the manufacturing report make it more likely that the Federal Reserve will cut interest rates at its next meeting Sept. 18.

The Tempe, Ariz.-based Institute for Supply Management, an organization of corporate purchasing executives, said its index of business activity in the manufacturing sector registered 52.9 in August, down from 53.8 in July. Wall Street economists were expecting a reading of 53, according to Thomson Financial/IFR. Readings above 50 indicate expansion and below 50 indicate contraction.

The Commerce Department, meanwhile, said Tuesday that construction spending dropped 0.4 percent in July, compared with June, the weakest showing since a 0.6 percent fall in January.

It was a bigger drop than economists had been expecting and underscored the continued drag the severe slump in housing is having on building activity.

There were several positive signs for the economy in the ISM survey. The production, employment and export indices increased, while new orders declined but remained above 50.

Manufacturers of agricultural equipment, aircraft and construction equipment, among others, have benefited from a weak U.S. dollar, which makes U.S. goods less expensive abroad.

“Overall, this report reinforces other indicators showing modest but uneven growth across the manufacturing sector,” David Resler, chief economist at Nomura Securities, wrote in a research note.

The stock markets rose, with the Dow up 44.87 points to 13,402.61 and the S&P 500 up 10.06 points to 1,484.05.

John Shin, senior economist at Lehman Brothers, said investors were encouraged by the fact that the ISM reading remained above 50, despite recent tightening in the credit markets stemming from mortgage defaults.

In addition, the prices paid index dropped to 63 from 65, its fourth consecutive month of decline. That could indicate that “inflation concerns are cooling off,” Shin said, which could enable the Federal reserve to cut rates at its next meeting Sept. 18.

At the same time, the ISM index isn’t high enough to indicate runaway growth, which would give the Fed pause, he said.

“When you add it all up, it’s more encouraging news for a market that’s really anticipating a rate cut in a couple of weeks,” Shin added.

The market is discounting the July construction spending data, he said, because it is a month old and reflects the well-known difficulties in housing.

Manufacturing exports remained healthy, with new export orders increasing to 57 from 56.5 in July.

Tom Runiewicz, industrial economist at economic consulting firm Global Insight, said Friday that approximately 30 percent of the farm and construction equipment made in the United States is for export.

Equipment maker Deere & Co. said last month that its third-quarter profit jumped 23 percent on strong international sales. Worldwide equipment sales grew 5 percent, mainly due to a 16 percent rise in agricultural equipment sales and a 15 percent improvement in commercial and consumer equipment sales, the company said.

The new orders index came in at 55.3, below July’s reading of 57.5, while the production index registered 56.1, an increase from 55.6 in July.

Copyright 2007 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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