After losing momentum over the last two months, manufacturing activity in the Northeast fell in August for the first time this year, reigniting concerns about a possible double-dip recession and raising the odds of an interest rate cut in September.

The Philadelphia Federal Reserve survey declined to minus 3.1 from a positive 6.6 in July and 22.2 in June. That was well below economists' expectations for a reading of 7.8. Because last month's report ushered in a wave of disappointing economic reports, some observers worry that the trend will be repeated.

"We have found that what we thought was a recovery is a much more sluggish pattern than is usual," said Carol Stone, deputy chief economist at Nomura Securities. "It may be that there's other kind-of-weak data."

Stocks took an initial dip on release of the survey but have since moved back into positive territory.

The Philly survey in July was followed by sharp declines in national manufacturing and non-manufacturing as well as slower job growth and weak second-quarter GDP figures. Prior to the data Thursday morning, the odds of a 25 basis point rate cut in September stood at just 38%, but fed-funds futures are now pricing in a 50% chance of a quarter-point cut.

The Federal Reserve left interest rates unchanged at a 40-year low of 1.75% this week. But the central bank did change its policy statement, warning that the risks are weighted towards conditions that may generate economic weakness.

RealMoney columnist Tony Crescenzi noted that in last 15 years, the Philadelphia survey went below zero 50 times and on 87% of those occasions the ISM index dropped below 50, indicating contraction. The ISM fell to 50.5% in July from 56.2% in June. Although Thursday's data don't necessarily suggest that a double-dip recession is coming, Crescenzi said the economy is "moving in that direction."

Stronger

Still, other pundits say they aren't convinced that the data presage further weakness. Anirvan Banerji, director of research at the Economic Cycle Research Institute (and occasional RealMoney columnist), believes the overall economy isn't doing too badly. He noted that industrial production rose 0.2% in July, that retail sales were up 1.2% and that 6,000 jobs were added to the payroll last month.

The Philadelphia survey "is consistent with the sense we've been getting from business that they suddenly pulled back last month and into this month," he said. "The question is whether there is persistent weakness because this may be just a blip based on a knee-jerk reaction to the market declines."

One disconcerting element of Thursday's report was the expectation index, which measures the six-month outlook. This also retreated in August amid a sharp drop in expectations for capital spending. Overall, the survey showed broad-based declines, with new orders and employment components witnessing the largest drop.

Banerji said the consumer hasn't pulled back to the same extent that businesses have and that barring further declines in the stock market, the economy should gradually recover.

Drew Matus, an economist at Lehman Brothers, said expectations were too high going into the Philly survey Thursday. He said economists read the New York Fed's Empire State Manufacturing report as an indication that the manufacturing sector overall is holding up. That index actually rose to 5.9 in August, up from negative 4.4 in July.

"It was a disappointing report," he said. "Coming in negative was a shock."

Still, Matus said that the Philadelphia survey was taken so early in the month of August, "it might as well be taken in July." The index isn't so much a reflection of current conditions, he said, but a mix of conditions in July and early August, when stock markets were performing poorly.

Other economic data seemed to confirm a downward trend Thursday. Industrial production rose 0.2% in July -- the slowest pace in three months. Excluding the 4.2% rise in auto production, output actually fell 0.1% -- the first decline this year.

Meanwhile, new claims for state jobless benefits rose by 6,000 to 388,000 in the latest week, above economists' expectations for a reading of 380,000. The four-week moving average of initial claims also climbed to 381,750 from 380,500, although the four-week moving average of continuing claims fell to 3.51 million -- the lowest since late February.

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