U.S. companies hired far fewer workers than expected in May and output in the manufacturing sector slowed to its lowest level since 2009, adding to concerns that the U.S. recovery is running out of steam.

Economists slashed their forecasts for Friday's payrolls report, considered the best barometer of the world's biggest economy, after private-sector job growth tumbled to just 38,000, its lowest level in eight months.

Wednesday's reports were the latest signals that economic growth remained sluggish in the second quarter after hitting a weak spot in the first months of the year.

It fits very neatly in with the puzzle we are putting together that speaks to another soft patch, said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey.

Factory growth around the world weakened last month, surveys from Europe to Asia showed, raising concerns that important export markets for U.S. companies are drying up.

The worse-than-expected U.S. slowdown could prompt the Federal Reserve to stick with its super-easy monetary policies for longer than previously thought.

It also fueled questions about whether the central bank might even embark on a third round of bond-buying to help prop up the economy, a move that would likely face opposition.

The Fed's current program of bond-buying, known as QE2, is set to expire at the end of June and has raised worries about whether the economy is strong enough to grow without it.

The end of QE2 will be to the U.S. economy what a lawnmower is to green shoots, said Douglas Borthwick, managing director at Faros Trading in Stamford, Connecticut.

The data sent Wall Street lower, with the broad S&P 500 down more than 1.5 percent in mid-afternoon trading.

The ADP report showed private payrolls fell from a downwardly revised 177,000 in April, well short of expectations for 175,000. It was the lowest level since September 2010.

Goldman Sachs and several other large financial institutions cut their estimates for Friday's non-farm payrolls figure in the wake of the ADP report.

A Reuters poll found payrolls likely increased by 150,000 in May, smaller than the 180,000 forecast before Wednesday's data.

MANUFACTURING EXPANSION SLOWS

The Institute for Supply Management (ISM) said its index of national factory activity fell to 53.5 in May from 60.4 the month before, missing economists' expectations for 57.7.

New orders, a barometer of demand ahead, fell to 51.0 from 61.7 in April, the lowest since June 2009.

Companies are managing inventories carefully according to consumer demand, and there did not appear to be a particular impact from supply chain disruptions after Japan's massive earthquake in March, said Bradley Holcomb, chair of the ISM Manufacturing Business Committee in Dallas, Texas.

The manufacturing sector had led the economy out of recession, helped by strength in demand from fast-growing emerging markets, but countries like China and India are trying to curb their acceleration. The export gauge of ISM fell to 55.0 from 62.0.

At the same time, General Motors Co and Ford Motor Co reported slightly lower U.S. vehicle sales in May as economic weakness and higher vehicle prices prompted consumers to delay major car purchases.

A separate snapshot of the jobs market showed the number of planned layoffs at U.S. firms rose modestly in May with the government and non-profit sectors making up a large portion of the cuts.

In a silver lining, borrowing by small U.S. businesses surged in April, data released by PayNet Inc showed. Small and medium-sized businesses are key to new hiring.

The housing market, which has lagged the recovery, continued to struggle as a report from an industry group showed applications for U.S. home mortgages fell last week, pulled lower by a decline in refinancing demand.

Home renovations, however, helped boost construction spending in April to its largest gain in six months, but the prior month's outlays were revised down sharply.

(Additional reporting by Ellen Freilich and Chuck Mikolajczak; Editing by Padraic Cassidy)

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