updated 10/4/2005 7:17:19 PM ET 2005-10-04T23:17:19

Orders to U.S. factories posted the best increase in three months in August as the manufacturing sector showed strength in the face of surging energy prices.

Major Market Indices

The Commerce Department reported that orders rose by 2.5 percent to $395.2 billion, led by strong demand for computers and other electronic products. The increase followed a 2.5 percent drop in July which had fed worries that manufacturing, an energy-intensive sector of the economy, could falter as crude oil prices climbed to record levels.

However, the August rebound and a big jump in September in a closely watched gauge of manufacturing sentiment should ease those worries. The Institute for Supply Management said that its index surged to a 13-month high of 59.4 percent in September despite the surge in energy prices and the battering the economy took from Hurricanes Katrina and Rita.

On Wall Street, stocks dropped sharply on Tuesday as several companies warned of profit shortfalls and investors grew concerned about higher interest rates. The Dow Jones industrial average fell 94.37 points to close at 10,441.11.

Richard Fisher, president of the Federal Reserve Bank of Dallas, sparked worries about interest rates when he remarked that inflation was nearing the high end of the Fed’s comfort signal. Markets viewed that comment as a signal that the central bank would keep raising interest rates in order to slow the economy and keep inflation from getting out of control.

The Fed on Sept. 20 boosted a key interest rate for the 11th time, indicating that it was more worried about inflation than what it believed would be a short-lived slowdown from Katrina.

Analysts at the Federal Deposit Insurance Corp. said in a new report Tuesday that losses from bad loans could increase “for a period” at banks in the Gulf Coast areas affected by Katrina and Rita.

“Although the full force of the impact of Hurricanes Katrina and Rita will not be fully known for some time, it is clear that the scope of the devastation is unprecedented for the local economies and is projected to slow U.S. economic activity in the third and fourth quarters,” said Barbara Ryan, head of regional operations for the FDIC’s insurance and research division.

The 2.5 percent increase in total factory orders in August was the best showing since a 4.2 percent rise in May.

Orders for durable goods, items expected to last three or more years, were up 3.4 percent in August, slightly better than 3.3 percent increase that the government estimated in a preliminary report last week.

The strength was led by a 5.5 percent surge in orders for computers and other electronic products.

Demand for cars, airplanes and other transportation equipment rose by 1.4 percent in July after a 9.1 percent plunge in transportation orders in July.

Excluding the increase in transportation, total orders would have been up by 2.7 percent, the best showing in this category in 17 months.

Orders for nondurable goods posted a 1.6 percent increase after a 1 percent increase in July.

Manufacturing was the hardest hit sector in the 2001 recession and there had been concerns that businesses might start cutting back on their orders out of concern over what rising energy prices might do to the economy.

Analysts said the strong reading from the manufacturing gauge in September showed that so far manufacturing outside of the Gulf Coast area has not been hurt by the hurricanes.

Economists still believe that the economy will see growth slashed by as much as a full percentage point in the second half of the year, reflecting a loss of perhaps 400,000 jobs from the hurricanes and the impact on consumer confidence from the surge in energy prices.

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