The non-manufacturing side of the U.S. economy, which had been the firmest pillar of the economic expansion, buckled in January, according...

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WASHINGTON — The non-manufacturing side of the U.S. economy, which had been the firmest pillar of the economic expansion, buckled in January, according to data reported Tuesday by the Institute for Supply Management (ISM).

Economists called it the clearest signal to date of a recession.

The index fell to a reading of 41.9 percent last month, down from 54.4 percent in December. It was the lowest level since October 2001.

It was also the largest one-month drop in the index’s history, coming in well below the 53.0 percent reading economists had expected.

Moreover, it marked the first reading below the 50 percent mark since March 2003, and the second-lowest reading ever to boot.

Readings below 50 percent indicate most firms are contracting.

Only three of 18 services industries tracked by the ISM were growing in January. Of these, just one — transportation — was hiring.

On Wall Street, stocks dropped sharply, undermined in large measure by the ISM index.

The Dow Jones industrial average fell 370.03, or 2.9 percent, to 12,265.13, the blue-chip index’s largest one-day point drop since it fell 387 points Aug. 9, 2007.

Microsoft, one of the 30 Dow stocks, fell $1.12 to close at $29.07. Boeing, also a Dow stock, fell $1.21 to $81.69.

The broader Standard & Poor’s 500 index lost 44.18, or 3.2 percent, closing at 1,336.64, while the Nasdaq composite index lost 73.28, or 3.1 percent, to 2,309.57.

In Monday and Tuesday trading, the Dow gave up the gains it made last week, when it jumped 4.4 percent.

It’s not surprising the volatile market would pull back. Some analysts claim stocks should be near their bottom given how low investor sentiment is now.

Economists said the data fit squarely within expectations that the Federal Reserve will continue to ease monetary policy in coming weeks.

The next formal meeting of Fed policymakers is March 18, but the U.S. central bank under Chairman Ben Bernanke has shown a willingness to make moves, when deemed necessary, in between meetings.

“Though it would be unusual for the Fed to change policy off a sentiment survey like the ISM-NMI, the mix of this weakness and the payroll drop will set the stage for Fed action if next week’s more significant reports for retail sales and trade make clear that GDP growth is indeed dangerously close to, or just below, zero,” said economists at Action Economics.

The January report on nonfarm payrolls showed a net reduction of jobs in the economy, the first such contraction in employment in more than four years.

Maybe not so weak

But some economists, unswayed by the reaction in financial markets, cautioned that the ISM services report might not be as weak as suggested at first blush.

“While we agree service-sector activity has been slowing, we doubt it is as dire as this number suggests,” said Sam Ballard, an economist at Wachovia.

“The reading for the ISM non-manufacturing composite, if sustained, is consistent with recession,” said Josh Shapiro, chief U.S. economist at MFR.

Nor did the details of the January report offer much to be optimistic about:

• New orders fell to 43.5 percent — the lowest level since October 2001 — from 53.9 percent in December.

• Employment dropped to 43.9 percent, down from 51.8 percent.

• Backlogs of orders fell to 46.0 percent from 49.0 percent.

• The prices-paid index came in at 70.7 percent, down from 71.5 percent.

• Inventories fell to 44.5 percent from 50.5 percent.

After the fact

Recession is defined as two successive quarters of negative economic growth, and the National Bureau of Economic Research formally declares them after the fact.

The bureau’s Business Cycle Dating Committee determines this based on “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales,” according to its Web site.

The president of the Federal Reserve Bank of Richmond, Jeffrey Lacker, said Tuesday he expected a sluggish 2008.

“I can also see the possibility of a mild recession, similar to the last two we have experienced; in other words, shallow and with a slow recovery,” Lacker said.

Stock market particulars provided by The Associated Press. Information about defining a recession provided by The Washington Post.