Service Sector Shrinks Unexpectedly in June

The U.S. service sector shrank unexpectedly in June, according to a report released Thursday, while inflation pressures soared to a record high for the survey's 11-year history.

ISM's measure of employment in the vital service sector hit a record low, which could fan fears of a return to low growth and high inflation, known as stagflation, that was last seen in the late 1970s and early 1980s.

The data also heightens the dilemma facing the Federal Reserve, which had cut benchmark U.S. interest rates to support the weak economy at the risk of fueling price pressures but which is now expected to keep them on hold while they see if inflation becomes a bigger problem for the U.S. economy.

The Institute for Supply Management's non-manufacturing index came in at 48.2 for June, versus 51.7 in May. A reading below 50 signals contraction.

"The non-manufacturing results were decisively weak in a survey that typically does not show decisive movements," said Pierre Ellis, senior economist at Decision Economics in New York. "There's a slow-motion decline in employment that has the effect of weighing more and more heavily on an economy that is running flat at best."

The ISM follows a report from the Labor Department that showed U.S. employers cut workers from payrolls for a sixth straight month in June for the longest losing streak for the labor market since 2002.

U.S. stock indexes turned lower after the weaker-than-expected ISM report while the dollar pared its gains versus the euro and yen.

Government bonds, which usually benefit from from weak economic conditions, received a brief lift but were last trading mixed.

Economists had expected a reading of 51.0, according to the median of 76 forecasts in a Reuters poll.

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

The services report follows an ISM gauge on Tuesday that showed manufacturing expanded in June for the first time in five months, helped by a weak dollar. That report also showed inflation pressures soared to their highest since the stagflation-ravaged 1970s.

If there was any good news for the Fed, it was the suggestion that the price rises in the service sector were not being passed on to consumers completely.

"Yes, prices are higher, but it's not a total pass-through to the end consumer," said Anthony Nieves, chair of the Institute for Supply Management's non-manufacturing business survey committee.

"It's more about eroding profit margins," Nieves told a conference call of journalists. "We've had specific comments on that in past months in the report as well."

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