Manufacturing Growth Less Than Expected In May (UPDATE)

WASHINGTON (AP) - The U.S. economy appears to be shifting into a lower gear with residential construction falling sharply and manufacturing activity slowing.

Those developments and a benign reading on wage pressures helped ease worries that an overheated economy might spawn inflation troubles.

A report from the Institute of Supply Management showed that its closely watched gauge of manufacturing activity turned in a weaker-than-expected reading of 54.4 in May. That was down from 57.3 in April and a sign, analysts said, of a significant slowing in momentum in manufacturing over the past four months.

Those developments plus a sharp downward revision in unit labor costs for the first quarter helped to calm Wall Street fears that inflation was threatening to get out of control. The Dow Jones industrial average was up in early trading Thursday.

The construction report was one of the strongest signs yet that the nation's five-year housing boom is cooling off, a development that reflects a campaign by the Federal Reserve to boost interest rates as a way of slowing the economy and keeping inflation under control.

In another report of slowing housing activity, the National Association of Realtors said its index for pending home sales fell for a third straight month in April, dropping by 3.7% from the March level. This index tracks sales of previously owned homes where a contract has been signed but the deal has not yet gone to closing.

David Lereah, chief economist for the Realtors, said that home sales, which set records for five straight years, are now ''falling from historic highs'' but appear set to stabilize at a solid pace for the year.

For April, total construction spending fell to a seasonally adjusted annual rate of $1.195 trillion. The 1.1% drop in residential construction was offset somewhat by a 2.5% rise in non-residential activity, reflecting solid gains in office, hotel and shopping center activity.

Spending for public construction projects dropped by 0.2% with state and local activity falling by 0.3% while spending on federal projects surged by 0.6% to an all-time high of $20 billion at an annual rate.

In other economic news:

_ The productivity of American workers rebounded at a rapid clip at the start of this year and wages posted a solid gain as well. The Labor Department said that productivity, the key factor in rising living standards, rose at an annual rate of 3.7% in the January-March quarter, better than the 3.2% increase initially estimated a month ago. Salaries and benefits per unit of output rose by 1.6% after having fallen by 0.6% in the fourth quarter.

_ The number of newly laid off workers filing claims for unemployment benefits unexpectedly increased to 336,000 last week, a gain of 7,000 from the previous week. Analysts had been expecting jobless claims would decline following recent increases that had been caused by temporary government shutdowns in Puerto Rico.

The increase in productivity represented a big rebound after productivity had fallen at an annual rate of 0.3% in the fourth quarter. It was the best quarterly showing since a 4.2% productivity increase in the third quarter of 2005.

The first quarter figure had originally been reported as a smaller 3.2% rise, but it was revised following the government's revision of overall economic activity, as measured by the gross domestic product, to a sizzling 5.3% rate for the first quarter, up from an initial estimate of 4.8%.

The 1.6% increase in unit labor costs, a measure of how much workers are paid per unit of output, was the fastest gain in a year but it was revised from a much higher 2.5% rate of increase that was reported a month ago.

While rising wages are good for workers, the Federal Reserve is constantly monitoring this compensation gauge to make sure labor costs are staying under control and not adding to inflation pressures.