Oct. 18 (Bloomberg) -- The pace of manufacturing in the Philadelphia area cooled in October, signaling economic growth is slowing.

The Philadelphia Federal Reserve Bank's general economic index fell to 6.8, from 10.9 in September, the bank said today. Readings greater than zero signal expansion.

The report showed sales fell by the most since September 2006, orders slowed and inventories dropped. Gains in exports and lean stockpiles will keep factories running even as consumer and business spending cool, economists said.

``Businesses are still very cautious and all it takes are signs of demand slowing for businesses to be pulling in a bit,'' said Michael Gregory, a senior economist at BMO Capital Markets in New York, who accurately forecast the drop. Manufacturing ``is getting some lift from exports, but maybe not enough to offset the impact from housing.''

Economists forecast the Philadelphia measure would fall to 7, according to the median of 58 projections in a Bloomberg News survey. Estimates ranged from 3 to 15.

A separate report today showed the index of leading economic indicators rose in September as stocks climbed and fewer Americans lost their jobs.

The Conference Board's index gained 0.3 percent, matching analysts' projections, the New York-based group said. The report reinforced forecasts by economists that the two-year housing slump will slow the economy without undoing the expansion that began in 2001.

Claims Jumped

First-time claims for jobless benefits jumped last week by a greater-than-forecast 28,000 to 337,000, the Labor Department also reported today. The increase, the biggest since February, raised concern the job market was softening.

The Philadelphia Fed's headline index is a separate measure that doesn't reflect the individual components. Some economists regard it as a gauge of business sentiment than of actual activity.

The index of new orders fell to 2.7, the lowest since March, from 15.1. Shipments dropped to minus 4.1 from 16.9 and the inventory index slumped to minus 15, the lowest since May 2002.

``While solid export growth will provide a cushion, weakening domestic demand will weigh on growth in the months ahead, particularly for housing and other big-ticket consumer items,'' said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., a New York forecasting firm.

More Hiring

One bright spot was that manufacturers were hiring. The Philadelphia Fed's employment measure rose to 12.6 in October from 7.5.

The bank's gauge measuring optimism about the future increased to 41.5, the highest since November 2004, from 35.7.

Other reports are showing manufacturing is withstanding challenges from the weak housing market and prospects of slower consumer spending. Earlier this week, the Fed Bank of New York said its regional economic index rose to 28.8, from 14.7 in September.

Both the New York and Philadelphia measures are less vulnerable to fluctuations in the auto industry and more exposed to financial services and exports, economists said.

The Institute for Supply Management is scheduled to release its national manufacturing report for October on Nov. 1.

This month's regional manufacturing surveys are giving economists an initial view as to the state of the expansion in the beginning of the fourth quarter. Some economists raised their projections for third-quarter growth last week after the Commerce Department reported record exports helped narrow the trade deficit in August.

Growth Forecast

How the turmoil in financial markets unfolds will be the most important determinant of the economy's performance next year, according to a Business Council survey of chief executives released Oct. 11. Most CEOs, 52 percent, forecast growth will slow to 2 percent or less next year, hindered by the increase in the cost of credit.

``I am much more worried about recessionary impacts rather than inflationary impacts,'' Rockwell Collins Inc. CEO Clayton Jones said in an interview on Oct. 11.

The government is scheduled to release its advance estimate of third-quarter growth on Oct. 31. The same day, Federal policy makers will vote on the direction of interest rates.

The central bank lowered its benchmark overnight lending rate by half a percentage point on Sept. 18, the first cut in four years.

Fed funds futures trading shows there is a 70 percent probability that the Federal Open Market Committee will reduce the rate by quarter percentage point on Oct. 31.

`Significant Drag'

Fed Chairman Ben S. Bernanke said this week the housing industry's contraction will be a ``significant drag'' on U.S. growth into next year, though evidence of a broader impact on spending is limited. He reiterated that policy makers will ``act as needed'' to secure growth and contain prices.

The report showed the jump in commodity prices took a toll. The Philadelphia Fed's index of prices paid jumped to 40.3, the highest since May 2006, from 23.1. The gauge of prices received rose to 12.4 from 3.3.

Petroleum prices may continue to pose a challenge to companies. Crude oil prices reached $89 a barrel for the first time ever in trading yesterday on the New York Mercantile Exchange.

To contact the reporter on this story: Courtney Schlisserman in Washington cschlisserma@bloomberg.net

Last Updated: October 18, 2007 12:45 EDT