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Services Economy Shrinks, But by Less Than Forecast

The services sector contracted in February, though not as badly as economists had expected, while factory orders fell in line with forecasts.

The Institute for Supply Management's non-manufacturing index came in at 49.3, above the record-low result of 44.6 in January but still slightly below the level of 50 that separates
expansion from contraction.

The NMI has now been below below 50 for two consecutive months, the first time it has been mired in such a slump since January 2002, when the economy was still feeling the effects of the last recession.

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

The services index follows a similar report Monday from the ISM that showed U.S. factory activity contracted in February, falling to its weakest in nearly five years.

"It reflects a bounce back from the very weak report from last month," Zach Pandel, economist at Lehman Brothers in New York, said of the ISM services report.

"It still suggests a moderate contraction in the service sector, bringing it closer to the (ISM) manufacturing series."

The newly introduced non-manufacturing index made its debut in the January report, but historical data exists based on its components.

Separately, new orders at factories fell 2.5 percent fell in January, in line with expectations and the first decline since August, while still another report showed worker productivity slowed sharply in the final three months of last year as the economy lost momentum.

Productivity -- the amount an employee produces for every hour on the job -- increased at an annual rate of just 1.9 percent in the October-to-December quarter. This key measure of workplace efficiency was down considerably from the third quarter's brisk, 6.3 percent growth rate and was the slowest pace since the first quarter of last year.

As productivity growth slowed, labor costs went up.

Employers' unit labor costs rose at a 2.6 percent clip in the fourth quarter. That compared with an annualized decline of 2.7 percent in the third quarter. It marked the largest increase in labor costs since the first quarter of last year. Unit labor costs is a measure of how much companies pay workers for every unit of output they produce.

Productivity Revised Upward

The revised reading on fourth-quarter productivity was slightly better than the 1.8 percent growth rate initially reported by the government. Economists were expecting no change in that initial estimate.

Wednesday's report included annual revisions based on more complete data.

For all of 2007, for instance, productivity rose 1.8 percent, up from a 1 percent gain in 2006. Labor costs, meanwhile, rose faster -- growing by 3.1 percent last year. In 2006, labor costs rose 2.9 percent.

Efficiency gains are important to the economy's long-term vitality. They can help blunt inflation. The gains can allow companies to pay workers more without raising prices, which would cut into paychecks.

For now, Federal Reserve Chairman Ben Bernanke's No. 1 mission is to help bolster overall economic growth. Many fear the United States is on the brink of a recession or already in one.

The economy nearly stalled in the final quarter of last year, growing at a pace of just 0.6 percent. Economists think growth could be even slower in the current quarter. Some believe the economy is actually shrinking now.

The Federal Reserve, which started cutting a key interest rate in September, recently ramped up reductions to shore up the economy. It slashed rates by an aggressive 1.25 percentage points in the span of just eight days in January. Bernanke last week signaled the central bank stands ready to lower rates again at its next meeting on March 18.

Even as the Fed fights to keep the economy going, it is keeping a sharp eye on inflation. Galloping energy prices, rising food costs and high prices elsewhere are straining pocketbooks and putting a further damper on economic growth.

Some worry that the country could be headed for a bout of stagflation -- a dangerous mix of stagnant economic activity and stubborn inflation. But Bernanke, in his congressional appearance last week, said he didn't believe that was the case.

The Associated Press contributed to this report.

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