The U.S. services sector contracted less severely in April and was back to its October 2008 level, a report on Tuesday showed, adding evidence the world's largest economy was nearing bottom and moving closer to recovery.

The Institute for Supply Management's non-manufacturing index rose to 43.7 from 40.8 in March. Any reading below 50 denotes contraction. Economists had forecast a smaller rise to 42.0 in the index.

The ISM non-manufacturing index contracted for the seventh consecutive month.

Basically this is what the market has been anticipating. The contraction is slowing. The rate of slowing is slowing, said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

On Wall Street, stocks fell as investors booked profits a day after the S&P 500 turned positive for the year.

U.S. government bonds, which generally benefit from signs of economic weakness, held onto their earlier losses.

The services sector represents about 80 percent of U.S. economic activity, including businesses like banks, airlines, hotels and restaurants.

The details of the ISM report also reflected a positive trend, with substantial improvements in gauges measuring employment and new orders.

Despite the improvement, however, the employment index remained mired in a slump, at 37.0 versus 32.3 in March.

(Additional reporting by Ryan Vlastelica; Editing by Kenneth Barry)

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