Service Sector Shrinks Less Than Expected in July

The U.S. service sector shrank slightly for the second consecutive month in July but by less than economists had expected, according to a report released on Tuesday that also showed inflation pressures moderating.

The Institute for Supply Management said its non-manufacturing index came in at 49.5 for July, up from June's 48.2. A reading below 50 signals contraction.

Economists expected a result of 48.5, according to the median of their forecasts in a Reuters poll. The 75 forecasts ranged from 47.0 to 52.5.

A decline in the report's prices paid inflation reading will come as positive news to the Federal Reserve as it meets to decide U.S. overnight interest rates on Tuesday. The prices paid index slid to 80.8 in July from June's 84.5, which was the highest in the 11-year history of the index.

Economists widely expect the Fed to keep its benchmark short-term rate steady at 2 percent, when it announces its decision around 2:15 p.m. (1815 GMT), but possibly signal more worry about price pressures after recent rises in other inflation gauges.

Despite the unexpectedly strong result in the overall index, the report was still weak, analysts said, which may heighten the Fed's worries over the stagnant state of the U.S. economy.

Analysts said a fall in the ISM's new orders index was of particular concern for future growth in the sector.

"The ISM non-manufacturing index was a little better than expected. But the breakdown is less positive given the fall in new orders," said Vassili Serebriakov, currency strategist at Wells Fargo in New York.

"This index indicates that the economy is marginally in contraction territory. I think the fall in new orders is a worrying sign."

Stocks extended their gains after the stronger-than-expected showing for the main index while the dollar remained in positive territory against the euro.

Government bonds, which perform better during periods of weak economic growth, slipped after the ISM report.

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

U.S. factory activity was unchanged in July from June, contrary to forecasts for a contraction, and inflation pressures moderated, according to a similar ISM report released on Friday.