By Lucia Mutikani
WASHINGTON, Aug 3 (Reuters) - U.S. manufacturing activity increased to the highest level in more than four years in July amid strong order growth, boosting factory employment, though the conflict in the Middle East is straining supply chains and keeping input costs elevated.
Responses in the Institute for Supply Management survey published on Monday were, however, overwhelmingly negative, with the U.S.-Israeli war with Iran dominating comments. Price volatility was also a common theme
among respondents, leaving some economists confident that the Federal Reserve would raise interest rates as soon as next month.
Still, the improvement in activity, especially the return to growth in manufacturing employment for the first time in 33 months, was cheered by economists.
"What we hear from purchasing managers is that the cost of everything coming in the door has gone up since oil prices jumped in early March," said Carl Weinberg, chief economist at High Frequency Economics. "Manufacturing companies will pass through those increased transportation costs as quickly as they can, just as truckers have already passed their higher costs through to manufacturers. The Fed will pay attention to this."
The ISM said its manufacturing PMI increased to 55.6 last month, the highest reading since May 2022, from 53.3 in June. Economists polled by Reuters had forecast the PMI would edge up to 54.0. The PMI this year has held above the 50 threshold, which indicates growth in the manufacturing sector.
Manufacturing, which accounts for about 9.4% of the economy, has been supported by businesses front-loading orders to avoid higher prices and shortages stemming from the war. An artificial intelligence buildout is also driving activity in the technology sector, blunting the hit on manufacturing from import tariffs.
With business inventories at very low levels, there is ample room for manufacturing to expand. The Fed reported last month that factory production grew at its fastest pace in four years in the second quarter.
Business inventories have declined for five straight quarters, the government reported last week.
Fifteen manufacturing industries, including electrical equipment, appliances and components, primary metals, transportation equipment, machinery as well as computer and electronic products, reported growth last month. The chemical products industry was the only one to report a contraction.
Susan Spence, the chair of the ISM Manufacturing Business Survey Committee, said 62% of the comments in last month's survey were negative and 38% were positive.
"Pricing volatility was mentioned in 57% of negative comments, the Iran war 43%, increasing lead times 22% and tariffs 18%," Spence said.
SUPPLY CONSTRAINTS
Some of the most negative comments were among primary metals producers, with one complaining there was "no normalcy in sight in the world of metals," adding that "it makes me yearn for the coronavirus pandemic chaos, which was more manageable than whatever this is that we are in."
Others noted that while business was at least better, the "components of good business are not." Manufacturers of electrical equipment, appliances and components reported that "the pricing volatility and lead-time extensions in this market are arguably worse than the pandemic era," adding that they were "seeing nothing but consistent upward trends for both pricing and lead times that show no signs of slowing down."
Makers of chemical products complained about "high freight costs, both for truck and ocean," adding that "longer lead times are concerning." Some manufacturers of transportation equipment reported increased costs and transit time "for rerouted shipments due to conflicts in the Red Sea, Strait of Hormuz and Suez Canal." Others said competing for scarce electronics and certain critical minerals, because of the AI buildout, was "challenging on-time fulfillment for our supply chains."
The ISM survey's new orders measure rose to 56.7 last month from 56.0 in June. Export orders surged and unfinished work piled up, prompting factories to boost employment. A measure of manufacturing employment rebounded to 52.8, the highest level since August 2022, from 49.7 in June. Sixty percent of respondents reported their firms were hiring, while 40% indicated they continued to manage headcounts, the ISM said.
Strong demand is, however, running into supply constraints.
The survey's supplier deliveries index increased to 58.9 from 57.4 in June. A reading above 50 indicates slower deliveries. The lengthening in suppliers' delivery times likely contributed to the jump in the PMI last month, as it is normally associated with a strong economy and high demand.
Supply constraints meant inflation at the factory gate remained elevated last month, though the pace of increase slowed. The survey's gauge of prices paid for inputs slipped to a still-high 71.1 from 73.0 in June.
That reading could reflect a retreat in oil prices in June amid a shaky ceasefire between the U.S. and Iran. Oil prices have since risen following the collapse of the truce in July.
Iran said on Monday there were no talks underway with the U.S. and no plans for any meetings, contradicting President Donald Trump who had cited talks he said would take place on Monday afternoon as justification for calling off attacks.
The Fed last week left its benchmark overnight interest rate in the 3.50%-3.75% range. Three members of the U.S. central bank's policy-setting committee dissented, preferring a quarter-percentage-point hike. Inflation risks are tilted to the upside because of the war, which is now in its sixth month.
Price increases were reported for many commodities, including integrated circuits and memory components. Several products, including aluminum, copper, electrical components, rare earth components and semiconductors were scarce.
"With demand for AI still rampant, we expect electronics prices to keep goods inflation up this year," said Matthew Martin, senior U.S. economist at Oxford Economics. "Cost pressures for manufacturers will be sticky in the near term."
(Reporting by Lucia Mutikani; Editing by Paul Simao)
