The Institute for Supply Management's manufacturing index fell to 46.2 last month, slipping from February's 50.5 measure. A reading below 50 means manufacturing activity is contracting. Analysts had expected war fears to cut into manufacturing, though not by this much, and had forecast a reading of 49.
Meanwhile, a survey of supply managers and business leaders indicated that higher energy costs are slowing the economic growth of a nine-state Midwest region.
The overall index in the Mid-America Business Conditions Survey dropped slightly in March to 53.7 from February's 53.9, Creighton University economics professor Ernie Goss said Tuesday.
Index numbers below 50 indicate a contracting economy and numbers above 50 indicate expansion.
Goss conducts the monthly survey in Arkansas, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, Oklahoma, and South Dakota.
Sharp drops in both new domestic and export orders were the prime factors pushing the overall index lower, Goss said. New export orders moved significantly lower to 46.8 in March from February's strong 53.7.
Uncertainty surrounding the war with Iraq was primarily responsible for much of the decline as firms moved away from buying in international markets, Goss said.
Norbert J. Ore, who oversees the ISM's national factory orders survey, also said he believes manufacturers were spooked by the threat of war and that manufacturing levels will reverse course this month.
"I think we'll see some recovery of this for the month of April as people see more clearly what the turn of events will yield for them," Ore said. "This was really built around the threat of what was going to happen."
The ISM, a private business group, wouldn't release the cutoff date of the March survey, making it difficult to gauge how much the start of the war affected responses. But Ore said manufacturers tend to know their business levels by the 10th of each month, and he believes the survey reflects more the threat of war than the actual March 19 start of the conflict.
New orders, which had been above the key 50 mark for six months, dropped sharply in March to 46.2 percent, or 6.1 percentage points lower than February's reading.
"War jitters undoubtedly hurt the economy but unseasonably severe weather and the decline in payrolls play an important role," said Dan Meckstroth, chief economist at Manufacturers Alliance, a business research group in Arlington, Va. "Declining production activity in manufacturing means that the overall economy cannot hope to achieve anything better than tread water in the months ahead."
Employment in the manufacturing sector failed again to recover in March, coming in below 50 for the 30th consecutive month. The index registered 42.1 percent last month.
"It's just been horrendous, the drop-off," Meckstroth said. "What's happening is there's very high productivity in manufacturing, about 3.4 percent a year on average, which means you have to have a 3.5 percent increase in production to keep jobs even. You have to have more than that to have job growth."
Instead, the ISM's production index fell 9.1 percentage points to 46.3 percent — below the pivotal 50 level — indicating a drop in business and ending 15 straight months of growth in production.
Meckstroth said the broader economy eventually will suffer by the lack of job growth in manufacturing, even though it accounts for only 14 percent of gross domestic product.
"Consumer confidence affects spending on a real short-term basis, but for the most part, people spend based on income and the buy ability of their job, and right now, we're just not getting employment growth," he said.
"Until capital spending improves significantly, I expect economic growth to remain at an unacceptably low rate," Goss said.
Separately, the Commerce Department reported Tuesday that construction spending dipped by 0.2 percent in February, pulled down by a sharp drop in government spending for big public works projects. Construction spending came to a seasonally adjusted annual rate of $872.2 billion, still a brisk level and better than analysts' expectations. The report suggested that the residential construction and housing markets continue to be one of the economy's few bright spots.
The Dow Jones industrial average was up 30.95, or 0.4 percent, at 8,023.08. The broader market was also higher. The Nasdaq composite index rose 2.18, or 0.2 percent, to 1,343.35. The Standard & Poor's 500 index advanced 3.35, or 0.4 percent, to 851.53.
The ISM said purchasing and supply executives focused mostly on the threat of war, but they also cited weak demand and rising prices.
Manufacturers continued to see higher prices cutting into their bottom line last month. The ISM's prices index was up for a 13th month, with higher costs in energy, gasoline, paper and chemicals.
Of the 20 industries in the manufacturing sector, only eight reported growth, including apparel, food, and wood and wood products.
The ISM's index is closely followed by economists and market watchers because it gives an early reading on the health of the manufacturing sector.
The index is based on a survey of managers who buy raw materials for manufacturing at companies across the country. The ISM made 450 questionnaires available in early March and the managers returned them via fax, e-mail or regular mail during the month. The group requires a minimum 60 percent response rate to compile its index.