Factory production shrank in December for the first time in nearly a year as tighter lending conditions and a slowing economy took their toll, according to a national survey published on Wednesday.
The Institute for Supply Management's manufacturing index, which had already slipped considerably in the second half of 2007, plunged to 47.7 last month, its weakest since April 2003. A reading below 50 points to contraction.
A drop in new orders also hinted at softening demand, even as companies paid higher prices for their inputs. The report darkened the outlook for the overall economy.
This will fan recession concerns, said Stephen Gallagher, U.S. chief economist at investment bank Societe Generale.
The most severe housing slump in more than a decade has underpinned such fears. Construction spending did rise 0.1 percent in November, but private home building saw its biggest decline in six years.
The surprisingly weak factory report sent stocks lower and bond prices sharply higher.
Credit markets have been experiencing turmoil in recent months as a crisis that began in housing spread into other areas of finance, raising fears of greater impact on the broader economy.
The economic data further muddies an unclear interest rate outlook. On the one hand, Federal Reserve officials seem reluctant to continue cutting interest rates given persistent price pressures, including those reported by ISM survey participants.
At the same time, the retrenchment in factory activity seems to require further stimulus from the central bank, if only to prevent the entire economy for hitting a more prolonged slump.
If both businesses and consumers get into a rut, then an already faltering economy could be in for serious trouble.
Manufacturing leads the rest of the economy, said Norbert Ore, chair of the ISM manufacturing business survey committee.
Already, weekly reports from chain store sales pointed not only to a lackluster holiday shopping season but also to weak post-holiday bargain hunting. Chain store sales fell 0.2 percent in the latest week, according to the International Council of Shopping Centers, while data from Redbook Research pointed to a 0.7 percent decrease.