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Manufacturing growth weakest in 2 years
ISM report contains signs that the industrial expansion may be running out of steam.
June 1, 2005: 1:58 PM EDT
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NEW YORK (CNN/Money) - Manufacturing growth slowed to the weakest pace in nearly two years in May, a survey of industry executives showed Wednesday, a sign the two-year-old industrial expansion could be running out of steam.

The report also pointed to far lower inflationary pressures at the nation's manufacturers, raising hopes on Wall Street that the Federal Reserve may soon pause or end its policy of raising interest rates at every meeting since June of 2004.

The Institute for Supply Management said its closely watched manufacturing index fell to 51.4 last month, down from 53.3 in April.

Any reading above 50 indicates growth in the sector, while a reading below that points to contraction. May was the 24th straight month of growth but was also the weakest reading since June 2003, when the current expansion in manufacturing was just getting started.

"While this represents the longest period of growth in the last 16 years, the data also indicates that the sector is losing momentum," Norbert Ore, chair of the ISM's Manufacturing Business Survey Committee, said in a statement. "The rate of growth in new orders continues to decline. The manufacturing sector is definitely slowing."

Economists surveyed by had forecast that the May index would come in at 52.0.

The group said the stronger dollar and high energy costs had become a drag on manufacturers. A stronger dollar makes U.S. goods more expensive to overseas buyers.

In its report, the group said its reading on employment fell to 48.8, ending 18 straight months of hiring growth in the sector. That shift comes ahead of Friday's closely watched May job report.

But the component showing the biggest drop was prices paid, which tumbled to 58.0 from 71.0 in April -- a sign that inflationary pressures were easing for manufacturers.

The percentage of those surveyed reporting paying higher prices fell to 32 percent from 52 percent in May, while those paying lower prices soared to 16 percent from 10 percent in April and only 5 percent in March.

The weaker-than-expected report and the lowered inflationary pressures fueled a big rally on Wall Street, as investors welcomed the prospect of a possible slowdown -- or pause -- in the Fed's rate hikes.

Stocks posted big gains and a bond market rally drove the yield on the 10-year Treasury down to 3.90 percent. Bond prices and yields move in opposite directions.

"The market has been worried about inflation and it has been worried about the Fed and this relieves them on both fronts," Milton Ezrati, senior economic strategist, Lord Abbett & Co., told Reuters.

But even with a contraction in manufacturing on the horizon and lower inflationary pressure, at least one Fed watcher said it's too soon to say the Fed is near the end of its "measured" rate hikes.

"This idea that the Fed is close to done is very puzzling," said Greg Valliere of the Stanford Washington Research Group.

"We should have economic growth of more than 3 percent this quarter. I think the Fed is concerned about a possible housing bubble and about us getting close to full employment. I think this is one of the rare occasions were the market has it wrong."

May marked the 11th straight month the ISM manufacturing index has declined. If manufacturing starts to contract, that can have implications outside the industrial sector.

For example, the Fed, the nation's central bank, has never raised rates during Chairman Alan Greenspan's tenure when the ISM manufacturing index stood below 50.0.

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