Business activity in the U.S. Midwest region grew at a slower pace in June, hit by an auto sales slowdown, while weekly mortgage applications also declined, reports showed on Wednesday.

The unexpectedly severe drop in the Chicago purchasing managers' index to an eight-month low echoed two successive monthly declines in durable goods orders in April and May.

Economists said the day's reports would support the Federal Reserve's (search) Open Market Committee goal of maintaining a "measured" pace as it starts raising interest rates.

"If we're beginning to see some moderation in activity, then it's more likely that the Fed will move rates up at a modest, or measured, pace," said Gary Thayer, chief economist at A. G. Edwards & Sons in St. Louis.

The National Association of Purchasing Management-Chicago (search) business barometer slid to 56.4 from 68.0 in May, and was at its lowest ebb since October. Economists had forecast the index at 65.0. A reading above 50 indicates expansion.

U.S. Treasury prices rose strongly on the report. The 10-year Treasury note yield fell to 4.60 percent, a one-month low, from 4.67 percent before the data. Stock prices slipped.

The Chicago survey is often seen as a litmus test for factory production, although both manufacturing and service industries are surveyed.

The Midwest region builds about 40 percent of U.S. motor vehicles and is a major producer of steel and farm equipment.

Of the 10 largest U.S. counties, Cook County, which includes Chicago and nearby suburbs, ranks second in terms of manufacturing jobs.

"Motor vehicle sales are slowing and I think that this probably contributed to the sharp drop in production that we saw in June," said Mark Vitner, economist at Wachovia Securities in Charlotte, North Carolina.

General Motors Corp.(GM), the largest U.S. auto producer, said this week that light vehicle sales will total a seasonally adjusted annual rate of 16.3 million in June, down from about 16.5 million in June last year.

In the Chicago report, the production and new orders components fell heavily, although the employment measure showed a third straight month of growth.

"What bothers me most is the drop-off in production and new orders. Durable orders have been dropping. The purchasing managers may be finally figuring out what's going on," said David Wyss, chief economist at Standard & Poor's Rating Services (search) in New York.

Meanwhile, the housing industry, a pillar of strength in the U.S. economy through both decline and recovery, is on what some see as its final fling before higher interest rates force a slowdown.

The Mortgage Bankers Association (search) said its seasonally adjusted market index, a measure of mortgage applications, fell 4.4 percent in the week ended June 25 after rising for two straight weeks.

The purchase index, a gauge of new loan requests for home purchases, fell 4.2 percent but was still at an historically high level.

Widespread publicity about pending interest rate increases has encouraged would-be buyers to jump into the market.

Short-term interest rate futures currently show expectations of a quarter of a percentage point tightening at each remaining FOMC meeting this year. As that scenario unfolds, the home mortgage market should weaken.

Another report on Wednesday showed New York City's economy improved for a 10th straight month in June, although inflation was seen as threat to expansion.

The NAPM-New York's (search) business conditions index, measuring the city's general business climate, has risen 28 percent in the past year. Expansion in the small manufacturing segment and in service industries helped drive the Big Apple index higher.