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Manufacturing Activity Revs Up As Incomes Dive On Tax Hikes

U.S. factories and automakers continue to make solid gains despite the worst income drop in 20 years and Europe showing no rebound, data showed Friday.

The Institute for Supply Management's manufacturing index unexpectedly rose 1.1 points in February to a 20-month high of 54.2. Analysts had predicted a dip. Readings above 50 signal expansion.

General Motors' (GM) February U.S. sales rose 7.2% vs. a year ago. Ford (F) saw a 9.3% gain. Chrysler and Toyota (TM) climbed about 4%.

U.S. stock indexes rallied modestly after falling early on the big personal income drop.

The ISM orders and backlog gauges were the best since April 2011, and exports were the strongest in nine months. Purchasing managers' comments in the survey suggested improvements are enabling investment and hiring.

"Automotive is still going strong, which allows budgeting for capital equipment," said a machinery company manager.

Meantime, Markit's eurozone factory gauge was flat at 47.9 last month. Germany's was positive, but France, Italy and Spain were deep in negative territory.

China's factory growth cooled, though the Lunar New Year was seen skewing February's data.

So far at least, U.S. factories aren't seeing ill effects from the tax hikes that hit Americans at the start of the year.

January incomes sank 3.6% from December due to the fiscal cliff deal tax hikes and dividend payouts rushed out in December. Analysts expected a 2.1% fall.

Spending rose 0.2%, though outlays on durables fell. The savings rate plunged to 2.4%, the lowest since November 2007.

Construction spending fell 2.1% in January, the first monthly retreat since March 2012. Residential spending was flat.

Looking past short-term volatility, the trend appears positive, said Mark Vitner, a senior economist at Wells Fargo: "It still seems the economy is gaining momentum month to month.

Demand from China is picking up and should lift exports. But consumers will feel more pressure from higher gas prices, he warns. Even before the tax hike, wage growth has been anemic.

The automatic federal spending sequester cuts going into effect also could worry consumers. But not yet.

The University of Michigan's February sentiment index was revised up 1.3 points to 77.6, making the gain from January even bigger. That signals consumers are absorbing the psychological impact of the payroll tax hike, says Joel Naroff, chief economist at Naroff Economic Advisors. And despite dire sequester predictions, Americans are used to the regular political standoffs.

"It's the cry-wolf syndrome," he said. "It's just another crisis."