The US manufacturing sector slowed dramatically in July and, with patchy growth in euro zone factories, added another layer of doubt about the durability of the global economic recovery.
The mounting signs of weaker growth underscored expectations that central banks on both sides of the Atlantic will keep interest rates low for longer. The Federal Reserve may indeed cut rates again if the US recovery falters.
Although most analysts do not believe the world's largest economy will slide back into recession, growth has turned sluggish after a bright start to 2002. It slowed to an anaemic 1.1 per cent annualised rate in the three months ended in June.
"What this does is puts the Bank of England and the (European Central Bank) on watch and raises the prospect of the Fed going one way whereas they might want to be going the other way. It puts back the day of an eventual tightening," said Carl Weinberg, chief economist at High Frequency Economics.
US stocks were rattled by the weak data, sagging across the board on Thursday. The broad Standard & Poor's 500 index closed down almost three per cent or 26.96 points at 884.66, while short-dated Treasury yields fell to a new closing low.
There was some bright news though on consumer spending, as sales of US-made automobiles jumped by more than eight per cent in July, fueled by aggressive discounting and zero interest-rate financing deals. Leading the way was a 24 per cent surge for General Motors Corp.
The US Institute for Supply Management said on Thursday its monthly manufacturing index fell to the lowest level in six months in July, to 50.5 from 56.2 in June. That put the index barely above the 50 level, which separates expansion from contraction.
"What is disturbing is it's very close to the level that would indicate that the industrial sector, which has been the engine of the nascent recovery, is stalling. That would be very troublesome," said Jade Zelnik, chief economist at Greenwich Capital Markets.
A recovery in factory production helped lift the US economy out of last year's recession, but there are concerns that consumers could close their wallets as uncertainty over the stock market and the economy grows.
Separate figures showed spending on new construction fell for a second straight month in June.
The news bolstered sentiment in US financial markets that the Federal Reserve might consider another cut in already low official rates to restore growth to a solid footing.
US President George W. Bush met with Fed Chairman Alan Greenspan for lunch on Thursday to discuss the economic outlook in what a White House spokesman said was one in a series of "periodic" meetings.
Now there is even some talk the European Central Bank may need to ease policy down the road.
Both the European Central Bank and the Bank of England kept their benchmark rates unchanged on Thursday after weighing a flurry of conflicting economic data.
On Thursday, manufacturing surveys showed that companies in the 12-nation euro zone were still enjoying modest growth in July. But in Britain, the world's fourth-biggest economy, manufacturers unexpectedly found business shrinking again.
In Europe's biggest economy, Germany, economists at the respected Ifo institute scaled back their growth forecasts.
The most positive news was that a survey of 2,500 euro zone manufacturers showed growth in the sector easing to an index level of 51.6 in July from 51.8 in June, remaining above the 50 line that divides growth from shrinkage.
"This indicator tells us that rates should be kept on hold. Looking further ahead, if there is going to be a change in ECB rates, it would rather be a cut than a hike," said Adolf Rosenstock at Nomura International in Frankfurt.
Germany's Ifo institute cut its German growth forecast for 2002 to 0.7 per cent from 0.9 per cent in April, saying recovery was still underway but at risk from financial market turbulence caused by accounting scandals in the United States.
The ECB decided to keep its key interest rate at 3.25 per cent.
The Bank of England also held rates at a 38-year low of four per cent despite data showing British house prices shot up last month at the fastest annual rate in 13 years.
In the United States, most economists think official rates will stay at the current 40-year low of 1.75 per cent for the rest of 2002. But a shock to financial markets or a sustained run of negative economic news could trigger another easing.
Weekly US jobless claims logged an unexpectedly sharp rise last week, figures on Thursday showed, rising 20,000 to 387,000. The labour market has barely grown all year as firms have remained reluctant to hire new workers although the pace of layoffs seems to have slowed.
US gross domestic product growth slowed sharply in the June quarter, although there was one positive sign as business spending on equipment rose. Policy-makers have said business investment will need to improve to keep the recovery on track.
"While consumer demand appears to have gotten off to a decent start this quarter, we expect weaker consumer and business spending growth late this year and in early-2003, implying slower growth in manufacturing as well," said Peter Kretzmer, senior economist at Banc of America.