Update: Industrial Production Dips 0.1%, While Inventories Inch Up

Updated from 9:37 a.m. EST

New data shows industrial production fell last month, while businesses posted a smaller-than-expected buildup in inventories in September, signaling the economy is slowing down and reinforcing expectations that the Federal Reserve Board will leave interest rates alone when it meets today.

The Federal Reserve Board reported Wednesday that industrial production fell 0.1% in October, contrary to expectations that production would increase by that amount. Production of durable consumer goods fell 2.5%, primarily because of a drop in auto and light truck assemblies.

Excluding the auto sector, overall industrial production was much closer to expectations, said Henry Wilmore, U.S. economist at Barclays Capital Group.

The automobile industry has suffered from lower sales revenues due to the high amount of discounted inventory, and production has been affected by factory shutdowns. Weaker auto sales were cited as a major reason for the slowdown in overall retail sales in October, reported Tuesday.

"It seems the industry is overly optimistic in terms of sales projections," said Wilmore, though he expects November production data to show a slight improvement.

October production also declined across other categories of durable consumer goods, with the largest decrease in the production of household appliances. By contrast, nondurable consumer goods rose 0.2%, extending a series of small gains posted over the past several months.

Analysts said the October drop appears to be more of a moderate pull back following the large increases in August and September than it is a sign of weakness in the industrial sector. Over the past three months, industrial production has increased at an annual pace of more than 3%, in line with expectations of a slowing economy.

Manufacturing capacity utilization fell by 0.3%, to 81.2%, helping to ease concerns of inflationary pressures. The slowdown in October industrial production also follows a month of unexpectedly low business inventory buildup, as businesses prepared for a slowdown in sales this season.

Business Inventories, Sales Up

The U.S. Commerce Department reported Wednesday that business inventories grew in September by just 0.1% -- the smallest increase in nearly two years, and sharply lower than August's 0.7% gain. Economists had expected a gain of 0.3%, according to Thomson IFR. Still, for the third quarter, inventories posted their largest quarterly gain in five years.

While stockpiling slowed, sales didn't. Businesses reported sales of $905 billion, as sales grew by 0.4% for the second month in a row (on revised August figures). That's a sharp reversal from the 0.6% sales decline in July.

A faster buildup in business inventories pushed the inventory to sales ratio up to 1.34 in August, but that figure dropped back to 1.33 in September and remains near its historic low. Economists expect inventory growth to become more closely aligned with sales during the fourth quarter.

The only businesses to add significant amounts to their stockpiled goods in September were those involved in making and selling building materials. They increased their building material inventories by 0.9% in September. However, furniture outlets cut their inventories by 1.3%, while auto dealers cut vehicle inventories by 0.3% from the previous month.

Meanwhile, manufacturers and merchant wholesalers boosted their stocks in September by 0.2%, but the gain was offset by a 0.1% drop in retail inventories. Manufacturers and marketers of big-ticket items, like major household appliances, also cut their inventories by 0.1% from the previous month. Inventories of nondurable goods increased by 0.3%.

The stockpiling slowdown seems to indicate that manufacturers and merchants are bracing themselves for slower sales growth in the fourth quarter, as higher interest rates and near-record oil and gas costs have made it more expensive for consumers to borrow money, heat their homes, and keep their cars running -- prompting many consumers to decrease or postpone purchases.

The inventory data may help ease inflationary concerns among federal monetary policymakers though. According to Francis Markey, an analyst at Economy.com, "The only impact of the release will be to further confirm the soft landing scenario and reassure analysts that inventory growth is slowing in line with sales growth."

The Federal Reserve Board's Open Market Committee is expected to leave rates unchanged when it meets this morning. The committee has raised rates a half-dozen times in the past 18 months but has left the benchmark-borrowing rate at 6.5% since May, issuing statements instead that indicate members remain concerned about inflationary pressures.