By AP Economics Writer
updated 3/5/2008 4:54:06 PM ET 2008-03-05T21:54:06

U.S. factories saw demand for their products drop sharply, while the country’s service sector contracted, fresh evidence of an economy hobbled by housing and credit crises.

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The Commerce Department reported Wednesday that new orders for manufactured goods fell 2.5 percent in January, a deterioration from December’s 2 percent increase. It was the biggest decline in five months.

“Businesses scaled back spending in an uncertain economic environment,” said Tim Quinlan, economic analyst at Wachovia.

Meanwhile, activity in the nation’s service sector shrank in February for the second straight month.

The Institute for Supply Management’s service sector index clocked in at 49.3. A reading below 50 indicates a contraction. In January, the index stood at 44.6.

The Federal Reserve, in a new snapshot of nationwide business conditions, reported that the economy has weakened since the start of the year, especially pinching retailers and manufacturers.

Manufacturers, service providers and others are feeling the sting of the economic slowdown. Persisting problems in the housing and credit markets are causing people and businesses to be more cautious. Galloping energy prices also are adding to the strains. Oil jumped to a new record of $104.52 a barrel.

The Fed reported that companies are getting hit by skyrocketing prices for energy and other raw materials. However, their ability to raise prices to their customers yielded mixed results.

On Wall Street, investors took the latest economic news in stride. The Dow Jones industrials closed up 41.19 points to 12,254.99.

The weakness in manufacturing was mostly concentrated in demand for costly “durable” goods, merchandise expected to last at least three years, the Commerce Department report showed. These orders — including cars, airplanes, machinery and computers — dropped 5.1 percent in January, compared with a 4.4 percent increase in December.

Demand for “nondurables,” such as food and clothing, edged up 0.3 percent in January, an improvement from a 0.4 percent decline in December.

In yet another report, worker productivity slowed sharply in the final three months of last year as the economy lost momentum.

The Labor Department reported that productivity — the amount an employee produces for every hour on the job — increased at an annual rate of just 1.9 percent in the October-to-December quarter. This key measure of workplace efficiency was down considerably from the third quarter’s brisk, 6.3 percent growth rate and was the slowest pace since the first quarter of last year.

As productivity growth slowed, labor costs went up.

Employers’ unit labor costs rose at a 2.6 percent clip in the fourth quarter. That compared with an annualized decline of 2.7 percent in the third quarter. It marked the largest increase in labor costs since the first quarter of last year. Unit labor costs is a measure of how much companies pay workers for every unit of output they produce.

Efficiency gains are important to the economy’s long-term vitality. They can help blunt inflation. The gains can allow companies to pay workers more without raising prices, which would cut into paychecks.

For now, Fed Chairman Ben Bernanke’s No. 1 mission is to help bolster overall economic growth. Many fear the United States is on the brink of a recession or already in one.

The economy nearly stalled in the final quarter of last year, growing at a pace of just 0.6 percent. Economists think growth could be even slower in the current quarter. Some believe the economy is already shrinking.

The Fed, which started cutting a key interest rate in September, recently ramped up reductions to shore up the economy. It slashed rates by an aggressive 1.25 percentage points in the span of just eight days in January. Bernanke last week signaled the central bank stands ready to lower rates again at its next meeting on March 18.

Even as the Fed fights to keep the economy going, it is watching inflation closely. Lofty energy prices, rising food costs and high prices elsewhere are straining pocketbooks and putting a further damper on economic growth.

Some worry that the country could be headed for a bout of stagflation — a dangerous mix of stagnant economic activity and stubborn inflation. But Bernanke, in his congressional appearance last week, said he didn’t believe that was the case.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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