By Lucia Mutikani

WASHINGTON (Reuters) -U.S. manufacturing contracted at a moderate pace in August amid some improvement in employment, but a further decline in new orders and rise in inventory suggested factory activity could remain subdued for a while.

The survey from the Institute for Supply Management (ISM) on Tuesday also showed manufacturers continuing to pay higher prices for inputs last month. It did not change expectations that the Federal Reserve will cut interest rates by 25 basis points when it kicks off its long awaited easing cycle this month.

"Input price pressures moved up modestly to the highest in three months, but they are not so high in our judgment to threaten continued slow disinflation," said Conrad DeQuadros, senior economic advisor at Brean Capital. "No bar to a September rate cut here but nothing to push the Fed to a half-point cut either."

The ISM said its manufacturing PMI rose to 47.2 last month from 46.8 in July, which was the lowest reading since November. A PMI reading below 50 indicates contraction in the manufacturing sector, which accounts for 10.3% of the economy.

The PMI remained below the 50 threshold for the fifth straight month, but was above the 42.5 level that the ISM said over time indicates an expansion of the overall economy.

Five manufacturing industries, including primary metals, furniture and computer and electronic products, reported growth last month. Machinery, textile mills, transportation equipment as well as electrical equipment, appliances and components were among the 12 industries reporting contraction.

The PMI and regional factory surveys have, however, consistently overstated manufacturing weakness.

So-called hard data on manufacturing production and business spending on equipment suggest the sector has been largely treading water, as demand for goods has not collapsed despite hefty rate hikes from the U.S. central bank. The Fed is expected to start cutting rates at its Sept. 17-18 policy meeting.

Comments from respondents in the survey were mixed. Chemical products makers reported "a noticeable slowdown in business activity." Machinery manufacturers described new order intake as "sluggish at best." But miscellaneous goods manufacturing said that "new orders continue to be strong."

Primary metals manufacturers reported that order books remained "strong for now," and were "running overtime to keep pace as hiring hourly employees has been difficult."

Stocks on Wall Street were trading lower. The dollar rose against a basket of currencies. U.S. Treasury yields fell.

WEAK ORDERS

The ISM survey's forward-looking new orders sub-index fell to 44.6 last month from 47.4 in July.

Output declined further, with the production sub-index slipping to 44.8, the lowest level since May 2020, from 45.9 in July. The ISM said the low level of production execution was "putting additional pressure on profitability."

Despite weak demand, manufacturers faced higher prices for inputs, likely reflecting soaring freight rates.

The survey's measure of prices paid by manufacturers increased to 54.0 from 52.9 in July a sign that raw materials prices increased for the eighth straight month, reversing eight consecutive months of decreases.

That suggests goods deflation has probably run its course for now, but will probably not have a material impact on inflation, which is slowing. Goods prices were unchanged in July after falling for two straight months.

The measure of supplier deliveries fell to 50.5 from 52.6 in the prior month. A reading above 50 indicates slower deliveries.

Factory employment contracted, though the pace slowed. The survey's manufacturing employment measure rose to 46.0 from 43.4 in July. Companies continued to reduce head counts through layoffs, attrition and hiring freezes, the ISM said.

This measure has not been a reliable predictor of manufacturing payrolls in the government's closely watched employment report.

According to a Reuters survey of economists, manufacturing employment was likely unchanged in August after edging up by 1,000 jobs in July. Overall nonfarm payrolls were forecast increasing by 160,000 positions after rising 114,000 in July.

The unemployment rate was estimated to have fallen to 4.2% from near a three-year high of 4.3% in July.

A second report from the Commerce Department's Census Bureau on Tuesday showed construction spending dropped 0.3% in July after being unchanged in June as higher mortgages and increased supply weighed on single-family homebuilding. Construction spending increased 6.7% year-on-year in July.

Investment in residential construction fell 0.4%, with outlays on new single-family construction projects plunging 1.9%. A surge in mortgage rates in the spring chilled homebuilding and sales, leading to an inventory overhang in some regions. The excess supply and weak demand has forced builders to hold back breaking ground on new projects.

Single-family homebuilding dropped to a 16-month low in July, with inventory near levels last seen in early 2008.

(Reporting by Lucia Mutikani; Editing by Paul Simao, Alexandra Hudson)