U.S. manufacturing unexpectedly expanded in August, showing the two-year economic recovery may be sustained.

The Institute for Supply Management's factory index fell to 50.6 last month, the lowest level since July 2009, from 50.9 in July, the Tempe, Ariz.-based group said Thursday. Economists projected the gauge would drop to 48.5, according to the median forecast in a Bloomberg News survey. Figures greater than 50 signal economic expansion.

As global demand for U.S.-made goods slows, cheaper commodity prices and a recovery from setbacks related to Japan's natural disaster have helped keep manufacturing from shrinking. The report runs counter to regional readings from Philadelphia and New York last month that showed factories contracted and contributed to a drop in equity markets.

"Sentiment has mostly been what's fueled a lot of the concern and negativity over the economic outlook in the last month," said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Conn. "The economy is going to be OK, not great, but we'll still certainly see an acceleration in growth from the first half of the year."

The Standard & Poor's 500 Index fell Thursday to 1,204.42, down 1.2%. Estimates for the index from 80 economists ranged from 44 to 52.

Orders shrink

The report showed orders shrank for a second month, production contracted for the first time since May 2009 and export bookings grew at the slowest pace since July 2009.

Several regional factory surveys last month showed that manufacturers tempered production as orders were scaled back. New York-area factories contracted for a third-straight month in August and manufacturing in the Philadelphia region shrank the most in more than two years.

"The economy was relatively worse than we would have expected or hoped and so that puts some pressure on all the businesses," Michael Hoffman, chairman and CEO of Toro, said on an Aug. 18 teleconference with analysts.

Federal Reserve officials last month discussed a range of ways to invigorate the recovery after the U.S. economy expanded at a 0.7% average annual pace in the first half of the year, according to Federal Open Market Committee minutes released Aug. 31. Fed Chairman Ben Bernanke said last week that the central bank still has tools to boost growth and that the economy will probably improve in the second half of 2011.

Job growth

While a weak dollar provided incentive for overseas customers to buy American-made goods and raw material costs moderated, a slowing global economy has raised worries export growth will cool. A lack of jobs and weakening consumer confidence in the U.S. also are reducing demand.

Shifting views on the economic outlook, along with Standard & Poor's downgrade of the U.S. credit rating last month, have also led to financial market volatility, which may prompt manufacturers to curtail output.

The S&P 500 Index fell or rose at least 4.4% in each of the first four days of the week ended Aug. 12, unprecedented consecutive swings in the American stock market, according to data compiled by Birinyi Associates, Bloomberg News and Howard Silverblatt, senior index analyst at S&P.

"It goes without saying that the volatility pervading in the financial markets is unsettling to the consumer," Kurt Darrow, CEO of La-Z-Boy, said on an Aug. 24 teleconference call.