LONDON, March 5 (Reuters) - U.S. manufacturers are

struggling to regain momentum as the sector tries to pull out of

the prolonged but shallow downturn, with any help from lower

interest rates delayed due to continuing inflation in the

service sector.

The desultory state of factory and freight activity has

limited diesel consumption, postponed the anticipated depletion

of fuel inventories, and caused refining margins to soften.

The Institute for Supply Management (ISM)'s purchasing index

slipped to 47.8 (18th percentile for all months since 1980) in

February down from 49.1 (25th percentile) in January.

The index has been below the 50-point threshold dividing

expanding activity from a contraction for 16 months running

since November 2022.

The manufacturing downturn has been the most prolonged since

the slowdown of 2000-2002 and before that 1981-1983.

Both of those downturns were cycle-ending recessions rather

than mid-cycle slowdowns, characterised by a far more severe

contraction in activity.

By contrast, in the current slowdown manufacturing output

has declined less than 2%, according to data from the U.S.

Federal Reserve.

Chartbook: U.S. manufacturing and diesel

The worst of the current downturn was over by the second and

third quarters of 2023, but manufacturers have since struggled

to regain momentum.

The ISM production sub-index slipped to 48.4 (14th

percentile) in February from 50.4 (22nd percentile) in January

and was no higher than in July 2023.

The new orders sub-index fell to 49.2 (20th percentile) in

February from 52.5 (34th percentile) in January and was no

better than September 2023.

Manufacturers often find it hard to regain momentum after a

mid-cycle "soft patch" - prompting the central bank to intervene

by cutting interest rates.

In this instance, however, rate reductions have been

postponed by residual strength in services. Persistent inflation

in the much larger and more labour-intensive services sector

limits scope to provide relief for manufacturers.

Makers of expensive items such as cars, furniture and

computer equipment need lower interest rates to spur household

and business spending and borrowing.

But with service sector prices rising more than twice as

fast as the central bank's flexible average inflation target,

policymakers have limited scope to supply more stimulus.

The central bank is confronted with a two-speed economy and

cannot aid manufacturers without risking services overheating.

DIESEL CONSUMPTION

U.S. consumption of diesel and other distillate fuel oils

has fallen in line with the shallow but prolonged slowdown in

manufacturing and freight activity.

There has been no sustained growth in distillate consumption

since the middle of 2022 as the manufacturing sector has been

stuck in the doldrums.

Petroleum-derived diesel consumption has actually fallen

because of the small but increasing market share captured by

biodiesel and renewable diesel.

The volume of petroleum-derived distillate fuel oil supplied

to the domestic market (a proxy for consumption) was down to 3.6

million barrels per day (b/d) in December 2023.

The volume slipped from 3.8 million b/d in December 2022 and

4.0 million b/d in December 2021, according to data from the

U.S. Energy Information Administration.

Over the same period, biodiesel and renewable diesel

supplied increased to 0.3 million b/d from 0.2 million b/d in

December 2022 and 0.16 million b/d in December 2021.

Despite lacklustre consumption, distillate stocks remain

well below the long-term average and have shown no sign of

rebuilding.

Extensive disruption of fuel manufacturing at BP's refinery

at Whiting in Indiana following a site-wide power failure has

added to the diesel shortage.

U.S. petroleum-derived distillate inventories were 15

million barrels (-11% or -0.93 standard deviations) below the

prior ten-year seasonal average on Feb. 26.

The deficit had widened from 11 million barrels (-8% or

-0.77 standard deviations) at the end of 2023, according to

weekly figures from the Energy Information Administration.

Distillate inventories are expected to tighten sharply once

manufacturing and freight activity starts to accelerate again,

putting strong upward pressure on fuel prices.

But slack industrial activity and fuel demand has pushed the

expected timeframe deeper into 2024 and caused fuel prices to

fall.

Prices for ultra-low sulphur diesel delivered in May 2024

are trading at a premium of around $31 per barrel over U.S.

crude, but the premium has slid from almost $40 in early

February.

Related columns:

- Persistent U.S. services inflation threatens soft landing

(February 14, 2024)

- Diesel prices primed to rise sharply in 2024 (February 6,

2024)

- U.S. manufacturers poised for resumed growth, diesel

shortage (February 2, 2024)

John Kemp is a Reuters market analyst. The views expressed

are his own. Follow his commentary on X https://twitter.com/JKempEnergy

(Editing by David Evans)