By Lucia Mutikani
WASHINGTON, Sept 18 (Reuters) - US factory production unexpectedly fell in August and higher oil prices and rising interest rates could offset some of the support from an artificial intelligence buildout, likely keeping activity moderate for the rest of the year.
The decline in output, reported by the Federal Reserve on Friday, followed seven straight months of increases. The US central bank on Wednesday raised interest rates for the first time in three years and flagged further increases in borrowing
costs in the months ahead. Oil prices are hovering above $100 a barrel with no end in sight to the US-Israeli war with Iran.
"Looking ahead, we think manufacturing output will rise a little further over coming months, but will fail to match the pace set in the first half of this year," said Samuel Tombs, chief US economist at Pantheon Macroeconomics. "Some manufacturers likely will find that demand softens as they pass on higher energy prices to consumers."
Manufacturing output dropped 0.3% last month following an unrevised 0.2% rise in July. Economists polled by Reuters had forecast production would increase 0.3%. Output advanced 0.9% on a year-over-year basis in August, a modest increase that, according to some economists, indicated the Trump administration's aggressive trade policy had not had the desired effect of rejuvenating the nation's industrial base.
Production in the sector, which accounts for about 9.4% of the economy, received a boost in prior months as businesses rushed orders to avoid shortages and higher prices from the escalation of the war in the Middle East.
The decline in August was led by a 0.5% drop in the production of long-lasting manufactured goods.
Motor vehicles and parts production decreased 1.2%, notching a second straight monthly decline. Output of computers and peripheral equipment fell 1.4%, but was up 5.5% on a year-over-year basis. Production of communications equipment increased 0.8%. Though the output of semiconductors and related electronic components dipped 0.1%, this category was up 12.4% from a year ago.
The AI spending spree has cushioned the blow from import tariffs on manufacturing. Some economists are still betting on a strong manufacturing performance this year, despite a sharp rise in longer-dated US Treasury yields in recent weeks and the Fed's decision to raise its benchmark overnight interest rate by 25 basis points to the 3.75%-4.00% range.
POSSIBLE TAILWIND FROM HIGHER DEFENSE SPENDING
"We still look for manufacturing activity to pick up through next year, and the AI infrastructure buildout is a key reason for our sanguine outlook," said Bernard Yaros, lead U.S. economist at Oxford Economics. "The demand case for AI still seems strong enough to shrug off higher-for-longer rates and increased geopolitical risk. Greater defense spending will also act as another tailwind."
Restocking by businesses that have run down inventories for five straight quarters to meet robust demand could also provide a lift to manufacturing, though some economists argued that trend could be overshadowed by the drag from rising costs.
Production of nondurable goods was unchanged after falling 0.4% in July. Rises in output at textile mills as well as for apparel and leather products were offset by declines in the production of plastics and rubber goods, and petroleum and coal.
"Factory output shows the first signs of a slowdown which could worsen if the geopolitical headwinds intensify and diesel fuel prices do not come back down," said Christopher Rupkey, chief economist at FWDBONDS.
"Soaring energy prices are costly for industry and higher diesel prices may start to chip away at the manufacturing renaissance picture painted by White House economic officials."
Mining production edged up 0.1% last month, matching the rise in July. Oil and gas well drilling increased 0.9% after accelerating by 5.2% in July. Utilities production shot up 1.8% after climbing 0.5% in July.
Overall industrial production was unchanged last month after gaining 0.2% in July. Industrial output advanced 1.4% on a year-over-year basis in August. Capacity utilization for the industrial sector, a measure of how fully firms are using their resources, was unchanged at 76.3% in August. It is 3.1 percentage points below its 1972–2025 average.
The operating rate for the manufacturing sector fell 0.3 percentage points to 75.7%. It is 2.5 percentage points below its long-run average.
"There is no evidence here that tariffs or anything are generating an influx of new jobs in manufacturing and industry," said Carl Weinberg, chief economist at High Frequency Economics.
(Reporting by Lucia Mutikani; Editing by Andrea Ricci and Paul Simao)
