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Factory activity fueling modest economic recovery

NEW YORK-- Hopes that America's factories will help drive the economic recovery gained support Monday from news that manufacturing activity grew in January to its strongest point since 2004.

Other data, though, offered a reminder that the recovery remains fragile. Construction spending sank in December to its lowest level in more than six years. And gains in personal income and spending were too modest in December to suggest that consumers can fuel a strong rebound.

"Right now we're getting a recovery," said Michael Gregory of BMO Capital Markets. "But you have to be skeptical. This kind of performance cannot be sustained unless we get those other areas that are still weak in the economy to contribute to growth -- housing, construction, real consumer spending."

Manufacturing activity has become a pocket of strength, though some of it flows from temporary factors such as customers needing to add to depleted stockpiles of goods.

The Institute for Supply Management said its manufacturing index read 58.4 in January, compared with 54.9 in December. It was the sixth straight month of expansion. Analysts polled by Thomson Reuters had expected a level of 55.5. A reading above 50 indicates growth.

New orders, a sign of future growth, jumped in January to its highest level since 2004. So did current production. Order backlogs grew, along with prices companies paid. Thirteen of 18 industries said they were expanding, led by the apparel, textile mills and machinery sectors.

China's manufacturing also expanded in January, and the outlook was positive despite government efforts to cool inflation by tightening control over bank lending, two surveys showed Monday.

U.S. manufacturers have been pumping up production to feed their customers' depleted stockpiles. The ISM said manufacturers' inventories contracted at a slower rate in January. Still, their customers' stockpiles fell to an all-time low.

As their customers try to restock their shelves, manufacturers need to ramp up production to match their demands. That could mean hiring more workers, which would help invigorate the economic rebound. ISM's employment measure grew last month.

"Production growth is finally beginning to tax existing work forces to the point where companies need to expand employment, and, critically, have enough confidence to do so," said Pierre Ellis of Decision Economics.

Last month, Oracle Corp. CEO Larry Ellison said the software company is hiring 2,000 people in the next few months to improve sales at Sun Microsystems, which it just acquired for $7.4 billion. At the same time, though, Oracle will fire about 1,000 people.

AK Steel Holding Corp. said in January that it had hired some new employees as production improved to about 85 percent of capacity, compared with 45 percent six months earlier.

Still, companies aren't hiring at a rate anywhere near enough to replace the more than 7 million jobs lost during the recession. The manufacturing sector has lost 2.1 million jobs.

"We're just not going to recapture those," said Wells Fargo chief economist John Silvia.

Unemployment held at 10 percent in December and is expected to remain elevated for years. The Obama administration included a measure in its 2011 budget for jobs that would give businesses tax breaks to promote hiring. President Barack Obama has also proposed tax incentives for businesses to invest in new plants and equipment.

The economy is also benefiting as a weak dollar boosts exports to fast-growing countries in Asia and Latin America. Monday's report said exports grew more quickly in January, to 58.5 from 54.5 in December. Economists warn, though, that high unemployment and tight credit for small businesses could make the inventory bounce short-lived.

Still, investors drew hope Monday from the positive signals in the economic reports. The Dow Jones industrial average surged about 80 points, or 0.8 percent, in early afternoon trading, and broader stock averages also rose.

The Commerce Department report on construction said home building fell by the steepest amount in seven months, evidence that housing remains a weak spot in the economy. Spending on new homes, office buildings and highways fell 1.2 percent to a seasonally adjusted annual rate of $902.5 billion, the lowest since August 2003. That was much worse than analysts' expectations of a 0.5 percent drop.

Housing activity was also weak in December because a new homebuyer tax credit was originally slated to expire in November, and many buyers rushed to complete purchases before the deadline. Congress has extended the credit through April and expanded it.

A separate Commerce report said personal incomes rose more than expected in December, and consumer spending increased for the third straight month. But income growth was spurred by a one-time Social Security payment. Wages and salaries rose only 0.1 percent, or $9.1 billion, after increasing 0.4 percent, or $27 billion, in November.

Many households are reluctant to ramp up spending amid tight credit and high unemployment. Widespread joblessness is also limiting wage and salary growth. Companies are finding it easier to retain workers without raising compensation.

"Consumers continue to save far more than in recent years and allocate their spending very carefully," Julia Coronado, an economist at BNP Paribas, wrote in a note to clients.

Incomes rose 0.4 percent, the sixth increase in a row. Consumer spending, meanwhile, increased by 0.2 percent, less than analysts' forecasts of 0.3 percent. The department also revised November's figure to show a 0.7 percent increase in spending, higher than the initial estimate of 0.5 percent.

Economists worry that once inventory levels are stabilized, manufacturing growth will slow as unemployment remains high and spending tepid.

"A short term burst of contribution from inventories and fiscal stimulus will fade," said Paul Dales of Capital Economics. "Consumption is not in any position to take up the slack."

Consumers seem less interested in buying than in saving and paying down their debts, said Dan Greenhaus, economic strategist at Miller Tabak. Americans saved 4.8 percent of their incomes in December, the department said, up from 4.5 percent the previous month. That's up sharply from the spring of 2008, when the savings rate fell below 1 percent.