U.S. Services Sector Gains Speed In July; Supply, Prices Pressures Easing

The U.S. services industry unexpectedly picked up in July as new orders grew solidly, supporting views that the economy was not in recession despite output slumping in the first half.

The Institute for Supply Management (ISM) survey on Wednesday also showed supply bottlenecks were easing, with a measure of prices paid by businesses dropping by the most since 2017. But shortages of labor, especially truck drivers, persisted.

"Availability issues with overland trucking, a restricted labor pool, various material shortages and inflation continue to be impediments for the services sector," said Anthony Nieves, chair of the ISM Services Business Survey Committee.

The ISM's non-manufacturing PMI rebounded to a reading of 56.7 last month from 55.3 in June, ending three straight monthly declines. Thirteen industries, including mining, public administration and wholesale trade reported growth. But agriculture, forestry, fishing and hunting, as well as retail trade and finance and insurance contracted.

Economists polled by Reuters had forecast the non-manufacturing PMI decreasing to 53.5. A reading above 50 indicates expansion in the services sector, which accounts for more than two-thirds of U.S. economic activity.

The surprise rebound followed the ISM's manufacturing survey on Monday showing factory activity slowing moderately last month. It was in stark contrast with the S&P Global survey showing the services sector shrinking in July.

The government reported last week that the economy contracted 1.3% in the January-June period.

Wild swings in inventories and the trade deficit tied to snarled global supply chains have been largely to blame. Overall economic momentum has, however, cooled as the Federal Reserve aggressively tightens monetary policy to fight inflation.

"The ISM activity is consistent with GDP growth of close to 2% annualized, rather than the outright declines seen over the first half of the year," said Michael Pearce, senior U.S. economist at Capital Economics in New York. "With borrowing costs down from their June peak, and falling gasoline prices likely to feed through to rising real disposable incomes, the immediate outlook for services is looking a little brighter."

The ISM's measure of new orders received by services businesses shot up to 59.9 from 55.6 in June. Businesses reported a rise in exports.

Services activity is being supported by a shift in spending from goods. But there signs of weakness are growing.

INVENTORY REDUCTION MODE

Accommodation and food services businesses reported that "restaurant sales have softened the past few weeks." Businesses in the management of companies and support services sector said they "can feel the economy weakening," and that "clients are making appropriate moves in anticipation of a recession."

Retailers said they were "in inventory reduction mode, attempting to match inventory levels to current lower sales trends." In the public administration sector, there was "pressure of a job market shortage for qualified workers to increase wages and other benefits."

The ISM's services industry employment gauge improved to 49.1 from 47.4 in June, which was the lowest reading since July 2020. Though demand for workers in industries like construction, wholesale and retail trade is easing, labor remains in short supply. The government reported on Tuesday that there were 10.7 million job openings at the end of June, with 1.8 openings for every unemployed person.

The survey's measure of supplier deliveries fell to 58.3 from 61.9 in June, helping to slow the pace of increase in services inflation. A reading above 50 indicates slower deliveries. Goods like appliances, computer hardware, electrical components, paper products as well as needles and syringes remained in short supply.

A gauge of prices paid by services industries for inputs declined to 72.3, the lowest reading since February 2021, from 80.1 in June. The 7.8 percentage points drop was largest since May 2017. This suggests that inflation has probably peaked.