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U.S. manufacturing activity slowed in July amid signs that a robust economy and import tariffs were putting pressure on the supply chain, which could hurt production in the long term.

Other data on Wednesday showed private employers stepped up hiring in July, suggesting strength in the labour market and the overall economy at the start of the third quarter.

“The rest of the year will be more challenging,” said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto. “Businesses are already having a tough time with tight labour markets and finding qualified workers and they have to deal with higher costs and slowing demand from overseas.”

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The Institute for Supply Management (ISM) said its index of national factory activity fell to a reading of 58.1 last month from 60.2 in June. A reading above 50 indicates expansion in manufacturing, which accounts for about 12 per cent of the U.S. economy.

The ISM described demand as remaining robust and noted “employment resources and supply chains continue to struggle.” It also said manufacturers were “overwhelmingly concerned about how tariff-related activity, including reciprocal tariffs, will continue to affect their business.”

President Donald Trump’s “America First” trade policy has embroiled the United States in tit-for-tat tariffs with major trade partners including China, Canada, Mexico and the European Union, which Trump says are taking advantage of the United States.

Analysts have warned that import duties could disrupt supply chains, undercut business investment and put a brake on strong economic growth. Signs of rising capacity constraints could draw the attention of the Federal Reserve, which is wrapping up a two-day policy meeting on Wednesday.

The U.S. central bank is expected to leave interest rates unchanged after increasing borrowing costs in June for the second time this year. The Fed has forecast two more rate hikes by the end of 2018.

While the ISM’s supplier deliveries sub-index dropped 6.1 points to 62.1 last month, the reading remained high after racing to a 14-year peak in June. Economists say trade tensions and the robust economy, marked by labour shortages and strong domestic demand, are behind delivery delays.

From food to machinery and primary metals industries, manufacturers said workers were scarce. Machinery manufacturers said many were falling behind schedule because of capacity constraints. Nearly all industries complained that operations were being hit by tariffs, which some said had raised prices for raw materials, including steel and aluminum.

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Manufacturers of electrical equipment, appliances and components said price increases “are real and will affect costs beginning in the third quarter of 2018.” Others reported stocking up before the duties came into effect, leading to an inventory buildup.

Transportation equipment manufacturers said higher raw material prices caused by the import duties would be passed on to domestic customers. Though the ISM survey’s prices paid index fell in July, it remained high. Seventeen of the 18 industries reported paying more for raw materials in the last month.

ORDERS DECLINE

Factories reported a decline in both new and export orders in July. Order backlogs also fell last month, but manufacturers hired more workers.

“With ... concerns rising over the impact of tariffs, which could weigh on exports and push up input prices, we suspect that the ISM index will continue to weaken gradually through the second half of this year,” said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.

The dollar was trading marginally higher against a basket of currencies, while prices for U.S. Treasuries fell. Stocks on Wall Street were mixed.

The economy grew at a 4.1 per cent annualized rate in the second quarter, the fastest in nearly four years and double the 2.2 per cent pace logged in the January-March period.

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Separately, the ADP National Employment Report showed private payrolls surged by 219,000 jobs in July after rising by 181,000 in June. Economists polled by Reuters had forecast that private payrolls would increase by 185,000 last month.

The ADP report is jointly developed with Moody’s Analytics. While it is not a good predictor of the private payrolls component of the government’s more comprehensive employment report, the report nonetheless supported expectations for solid job gains in July.

According to a Reuters survey of economists, nonfarm payrolls likely increased by 190,000 in July after advancing by 213,000 positions in June.

The unemployment rate is forecast falling one-tenth of a percentage point to 3.9 per cent in July. Job growth averaged 215,000 per month in the first half of this year.

A third report from the Commerce Department on Wednesday showed construction spending recorded its biggest drop in more than a year in June as investment in both private and public projects fell, but spending for the prior months was revised sharply higher.

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