By Lucia Mutikani
WASHINGTON (Reuters) - Factory activity grew at the slowest rate in three months in March, suggesting the economy lost some momentum at the end of the first quarter as the effects of tighter fiscal policy started kicking in.
Data so far this year had shown little sign that higher taxes, and the $85 billion in across-the-board government spending cuts that took effect March 1 known as the "sequester," had weighed on economic activity.
"It suggests the economy was probably starting to slow at the end of the quarter, possibly reflecting the impact of the fiscal headwinds coming from sequestration and higher taxes," said Millan Mulraine, a senior economist at TD Securities in New York.
The Institute for Supply Management said on Monday its index of national factory activity fell to 51.3 last month from 54.2 in February. A reading above 50 indicates expansion in the manufacturing sector. New orders, a key indicator of future growth, accounted for much of the drop in the index.
The ISM report was at odds with a separate report showing that factories gained steam in March on strong order growth, closing out the best quarter for the sector in two years.
Financial data firm Markit said its Manufacturing Purchasing Managers Index rose to 54.6 last month from 54.3 in February. A reading above 50 indicates expansion.
While the two surveys use the same sub-indexes, they assign different weights to the components.
Economists and investors placed more emphasis on the ISM survey, which has a longer history and has been generally a good gauge of overall U.S. economic activity.
U.S. stock prices fell in light trade, with the Standard & Poor's 500 index stepping back from last Thursday's record closing high. U.S. financial markets were closed on Friday for Good Friday.
The price for the longer-dated U.S. government bond rose, while the dollar fell to a near month low against the yen.
"We are beginning to see where the government spending cuts will reduce demand," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. "In those sectors and parts of the country that will feel the wrath of sequestration, adjustments are being made."
ROBUST FIRST-QUARTER GROWTH EYED
The U.S. Labor Department employment report for March to be released on Friday could shed more light on the U.S. economy's health.
Though factory activity slowed last month, there were pockets of strength. Export orders approached a year high and factory employment was the highest since June.
In addition, both manufacturers and their customers maintained lean inventories, which economists said pointed to a ramping up of activity later this year.
Last month's pullback did not, however, change perceptions that economic growth in the first quarter accelerated after almost stalling in the last three months of 2012.
The upbeat picture for the first quarter was bolstered by a Commerce Department report on Monday showing that construction spending advanced 1.2 percent in February. Spending had declined 2.1 percent in January.
The construction report added to a series of other data that has suggested economic growth accelerated in the first quarter from the fourth quarter's anemic 0.4 percent annual pace.
Data on employment, consumer spending, industrial production and housing have been relatively strong.
Some economists raised their growth estimates for the January-March period in the wake of the construction report.
Macroeconomic Advisers lifted its forecast by one-tenth of a point to 3.6 percent. JPMorgan raised its estimate from 2.7 percent to 3.8 percent. Part of the increase reflected strong consumer spending.
The U.S. Commerce Department released the consumer spending report on Friday, when financial markets were closed.
Construction spending in February was boosted by a 1.3 percent rise in private construction projects. Spending on private residential projects increased 2.2 percent to the highest level since November 2008.
Part of the increase reflected renovations. The housing market is no longer a drag on the economy and residential construction contributed to growth last year for the first time since 2005. It is expected to do so again this year.
"Housing is catching fire," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "All the conditions are in place for further improvement with housing even with lingering risks. Housing will keep the economy going forward even with the fiscal constraints."
Spending on private nonresidential structures rose 0.4 percent after declining 5.9 percent.
Public sector construction spending increased 0.9 percent, rising for a second straight month. Outlays on federal government projects fell 1.1 percent.
State and local spending, which is far larger than federal projects, rose 1.1 percent. It was the second straight month of gain in state and local government outlays.
(Additional reporting by Luciana Lopez, Steven C. Johnson and Richard Leong in New York; editing by Neil Stempleman, Leslie Adler and James Dalgleish)