Nov. 3 (Bloomberg) -- Manufacturing in the U.S. contracted in October at the fastest pace in 26 years as a record share of banks made it tougher to get loans and faltering economies abroad eroded prospects for American exports.

The Institute for Supply Management's factory index fell to 38.9 from 43.5 in September; 50 is the dividing line between expansion and contraction. The Commerce Department said separately that construction spending fell for the eighth time in 10 months in September.

Today's report may add to pressure for further interest-rate cuts and an additional federal package of tax and spending measures. The figures also showed the weakest level for U.S. export orders in the two decades the ISM has kept the data, a sign of slowdowns in Europe and Asia.

``Manufacturing is definitely in a deep recession right now,'' John Lonski, chief economist at the Moody's Capital Markets Group in New York, said in an interview with Bloomberg Television. ``We're definitely going to have more rate cuts'' and possibly ``more in terms of fiscal stimulus.''

Stocks were little changed, erasing earlier gains on concern the weakening economy would hurt profits. The Standard & Poor's 500 index declined 0.3 percent to close at 966.3 in New York.

A record share of U.S. banks made it harder for companies to get loans in the past three months as they tried to avert losses from the financial crisis, Federal Reserve also said today based on results of a survey of loan officers at domestic and foreign banks conducted Oct 2 to Oct. 16.

Economist's Forecasts

The Tempe, Arizona-based ISM's index was projected to drop to 41, according to the median of 75 economists' forecasts in a Bloomberg News survey.

The reading for October was the lowest since September 1982, adding to the series of dire economic news that has focused voters' attention ahead of tomorrow's presidential election. Figures last week showed consumer spending tumbled in September, capping the weakest quarter in three decades, while gross domestic product declined 0.3 percent in July to September.

As financial markets imploded in the last two months and the Bush administration led a massive bid to rescue credit markets, Democratic candidate Barack Obama took the lead in polls over Republican rival John McCain as voters perceived the Illinois senator would be better able to address economic concerns.

October's ISM reading corresponds to a 0.7 percent annualized drop in GDP, the group said today. The export gauge dropped to 41, the lowest reading since records for this component began in 1988.

`Burned Out'

``The domestic economy was already weak, and we were kind of hitching a ride on the overseas economy,'' said Brian Bethune, chief U.S. financial economist at IHS Global Insight in Lexington, Massachusetts. ``That beacon of light from overseas economies has basically burned out.''

European Commission officials today said the region's economy probably entered a recession this year and will stagnate in 2009. Japanese Economy Minister Kaoru Yosano said last month that his government is trying to avert a ``serious recession'' in his nation.

The U.S. purchasing managers' gauge of new orders for factories decreased to 32.2, the lowest level since 1980, from 38.8 the prior month. The production measure fell to 34.1 from 40.8.

The index of prices paid dropped to 37 from 53.5. Energy prices have plunged from their peaks in July, when a barrel of crude oil reached $147.

Hit to Jobs

Job losses accelerated, today's report also showed. The employment index decreased to 34.6 from 41.8 in September. Employers have cut more than three-quarters of a million jobs so far this year, and economists predict the Labor Department in four days will report that the unemployment rate climbed to 6.3 percent in October, matching the highest level since 1994.

The seizing-up of credit markets since mid September has worsened the economic outlook. Companies are cutting back on investments and hiring as consumer spending in the third quarter plunged by 3.1 percent, the biggest decline in 28 years.

General Motors Corp., the largest carmaker, today said sales of cars and light trucks tumbled in October by 45 percent from a year earlier. Adjusting for population growth, the monthly sales figure was ``probably the worst industry sales month'' since World War II, North America sales chief Mark LaNeve said in a statement, citing the ``unprecedented credit crunch.''

The economy shrank at a 0.3 percent pace in the third quarter, with spending on equipment and software declining at a 5.5 percent rate, the biggest drop since the first quarter of 2002. Economists surveyed by Bloomberg forecast the economy will shrink at a 0.8 percent rate in the fourth quarter.

In a bid to avert the downturn from becoming the worst recession in the postwar era, the Federal Reserve last week cut its key rate a half point to 1 percent, matching a 50-year low.

``Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports,'' the Fed said. ``Downside risks to growth remain.''

To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: November 3, 2008 16:27 EST