Published: Wednesday, 5 Aug 2009 | 11:23 AM ET

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The U.S. service sector contracted in July at a faster pace than in June, adding to worries that any economic recovery may still be a long way off, according to a report released Wednesday.

The Institute for Supply Management's services index fell to 46.4 last month from 47.0 in June, below economists' median forecast for a rise to 48.0. The dividing line between growth and contraction is 50.

"There is a clear lag in the recovery in the services sector, which reflects the anemic consumer part of the economy," said Richard DeKaser, president of Woodley Park Research in Washington.

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

U.S. stock markets extended losses, while Treasury debt prices shed losses and turned higher following the release of the data.

The last time the index was above 50 was in August 2008, which was followed by a reading of 50.0 in September 2008. The prices paid component of the index fell to 41.3 in July from 53.7 in June, while the new orders index eased to 48.1 from 48.6 in June.

The employment index fell to 41.5 in July from 43.4 the previous month.

The dip in the employment component added to worries that the size of any contraction in non-farm payrolls in July, to be released by the government Friday, might be larger than originally forecast.  Those worries had already been fueled by the ADP Employer Services report earlier Wednesday showing a bigger-than-expected contraction in private payrolls in July.

"This is not good news for the labor market given the disappointing ADP reading — it doesn't bode well for the July payroll reading," DeKaser said.

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The median of forecasts from analysts polled by Reuters is for non-farm payrolls to have contracted by 320,000 in July, after the loss of 467,000 jobs in June.

In a separate report released Wendesday, new orders received by U.S. factories unexpectedly rose in June, advancing for a third straight month and raising cautious hopes of a turnaround for the recession-hit economy.

The Commerce Department said factory orders climbed 0.4 percent in June after increasing by a revised 1.1 percent in May, previously reported as a 1.2 percent rise. Economists polled by Reuters had expected factory orders to fall 1 percent in June from the prior month.

While factory orders data was strong, reports on the services sector and the labor market were weaker.

"The general theme is that the restocking is basically better than expected with factory orders," said Doug Roberts, chief investment strategist at Channel Capital Research in Shrewsbury, N.J. "With factory orders, we've been a service-oriented economy so a restocking if there's no ultimate demand at the other end can be temporary and non-sustainable. So that's the big concern right now."

Excluding transportation items, factory orders surged 2.3 percent in June from May's 0.9 percent advance. Shipments of manufactured goods rebounded 1.4 percent in June, breaking 10 straight months of declines, the department said. Shipments fell 0.8 percent in May.

Inventories of manufactured goods fell 0.8 percent in June, matching the drop in May.

"The fact is the U.S. economy is improving, but is that a surprise? No, it's not considering where we were at the beginning of the year. The question is how quickly we can recover and how sustainable is that recovery," said Joe Trevisani, chief market analyst at FX Solutions in Ridgewood, N.J.

Orders for costly manufactured durable goods — items like cars and refrigerators intended to last longer — were down 2.2 percent in June instead of the 2.5 percent drop previously reported. That followed a 1.3 percent rise in May.

Shipments of manufactured durable goods fell 0.1 percent in June, dropping for the 11th consecutive month, instead of the previously reported 0.2 percent decrease. Inventories of manufactured durable goods fell 1.2 percent in June compared to the 0.9 percent drop previously reported.

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