NEW YORK (Reuters) - U.S. factory activity shrank in September to its lowest since the 2001 recession, and private employers shed jobs for the third time in four months as the financial crisis tightened its grip on the world’s largest economy.

Auto assembly line robots weld on the frame of 2009 Dodge Ram pick-up trucks at the Warren Truck Assembly Plant in Warren, Michigan September 12, 2008. REUTERS/Rebecca Cook

U.S. private-sector employers cut 8,000 jobs in September, according to a report by ADP Employer Services and Macroeconomic Advisers that did not include the impact of the financial chaos of the past few weeks.

Worse yet, the U.S. unemployment rate may increase to 7 percent by the middle of 2009, as poor jobs conditions are expected to persist for another 9 to 10 months, Macroeconomic Advisers Chairman Joel Prakken said.

Separately, the Institute for Supply Management said its index of national factory activity fell to 43.5 in September from 49.9 in August, under the level of 50 that separates contraction from expansion.

That was the worst reading since 40.8 in October 2001, when the economy was still mired in the last recession. Factories have held up relatively well in the current slowdown thanks to booming exports, but the report indicated a stalling global economy was taking its toll.

“For the first time, it’s really starting to look like a recession,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco.

“Maybe we don’t get that number in the fourth quarter necessarily, but it’s going to be tough at this point to avoid a recession.”

On Wall Street, stocks ended the day lower. Government bonds, which usually benefit from signs of economic weakness, rose on the day. However, markets remained transfixed by speculation over a possible bailout for the financial sector.

The U.S. Senate was gearing up to vote on a revised $700 billion U.S. financial bailout bill after 7:30 p.m.. The House, which rejected the original plan on Monday, was likely to vote on Friday, a senior aide said.

THE PICTURE OF WEAKNESS

The ISM report painted a comprehensive picture of weakness, which may only get worse as turmoil in the financial sector further constrains the credit companies need to fund their business.

The ISM manufacturing employment index hit its lowest since April 2003. The outlook also looked bleak, with the new manufacturing orders index sinking to its lowest since January 2001 and the export index sliding to its lowest since July 2006.

“We can’t see strength in the overall index in the next couple of months,” said Norbert Ore, head of the ISM’s Business Survey Committee.

Meanwhile, planned layoffs at U.S. companies rose 7.2 percent from a month earlier in September but jumped 33 percent from the same month a year ago, according to a report by employment consulting firm Challenger, Gray & Christmas Inc.

The September job cuts brought the third-quarter layoffs total to 287,142, the highest quarter of cuts since the fourth quarter of 2005, the report said.

However, the figures might not fully reflect the recent trauma in finance, which included the record bankruptcy of Lehman Brothers Holding Inc and the collapse of Washington Mutual, the largest U.S. bank failure.

“It may take several weeks or months for the fallout from September’s Wall Street turmoil to hit the employment numbers,” John A. Challenger, chief executive officer of Challenger, Gray & Christmas, was quoted as saying in the report.

It was a similar story for the ADP data, which comes ahead of the government’s comprehensive labor market report on Friday that is expected to show the U.S. economy as a whole shed jobs for a ninth consecutive month in September.

The September non-farm payrolls report from the Labor Department is expected to show a loss of 100,000 jobs, according to a median estimate from economists.

Last month’s ADP payroll readings were gathered prior to the financial chaos over the past several weeks.

“It’s really older news,” said Prakken, of Macroeconomic Advisers, about the September ADP report.

A machinists’ strike at Boeing and disruptions from Hurricane Ike could add 77,000 job losses to the BLS data for September that were not reflected in the ADP data, he said.

Prakken said the ADP report does not count these events as job losses, though he added that they are likely to be reflected in the BLS payroll survey.