Service Sector Growth Steady in August

U.S. service sector growth held steady in August, although employment conditions deteriorated to their weakest level in nearly five years, according to a report released Thursday.

The read on the service sector followed other economic reports on worker productivity, jobless claims and home prices. This economic data is being examined closely by investors, who are wondering whether the Federal Reserve will act to change rates later this month.

The strength in the service sector as well as a decline in the number of jobless claims this week reduced expectations for a cut in official interest rates.

The Institute for Supply Management's services index was unchanged in August at 55.8 from July, above Wall Street forecasts for a drop to 54.8. A number above 50 indicates growth.

The ISM's employment index fell to 47.9 in August, its lowest since December 2002, from 51.7 in July.

The prices paid index eased to 58.6 last month from 61.3, while the new orders index rose to 57.0 in August from 52.8 in July.

"We are getting mixed messages on the economy -- looks like tight credit is slowing business down," ISM's respondents from the professional, scientific and technical services said, according to an ISM statement.

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

Inflation Worries Could Ease

Meanwhile, U.S. worker productivity rebounded, growing at the fastest pace in nearly two years, while wage pressures eased sharply in the spring -- developments that should reduce inflation worries.

The Labor Department reported Thursday that productivity, the amount of output per hour of work, jumped to an annual growth rate of 2.6 percent in the April-June quarter, even better than the 1.8 percent increase that was originally reported.

Wage pressures, as measured by unit labor costs, slowed to an annual growth rate of 1.4 percent, slower than the initial estimate that labor costs were rising at a 2.1 percent rate.

Rising wages are good for workers, but if those gains are not accompanied by increased productivity, they can trigger unwanted inflation. If productivity is growing, it allows businesses to pay their workers more out of the increased output rather than by raising prices.

The increase in productivity and the reduction in labor costs were better than had been expected, raising hopes that the Federal Reserve will have the leeway to cut interest rates at its next meeting on Sept. 18.

Investors are hoping for such a move to insulate the economy from the steepest housing slump in 16 years, and from the turbulence in financial markets stemming from rising mortgage defaults.

Jobless Claims Fall

In other economic news, the number of newly laid off workers filing claims for unemployment benefits fell last week for the first time in seven weeks. The improvement was double what had been expected.

The Labor Department reported that jobless claims dropped to 318,000, down 19,000 from the previous week. A string of increases in jobless applications had raised concerns that the severe slump in housing was beginning to take its toll on the labor market.

In another hopeful sign, the nation's retailers reported that consumers returned to the malls in August. A late back-to-school shopping spree helped retailers rebound from lackluster sales in July. However, economists are still concerned that the weakening housing market and turbulent financial markets might hurt future sales.

Among the big chains reporting strong sales in August were Wal-Mart Stores and Target.

The government will report August jobless figures on Friday. The expectation is that the unemployment rate will hold steady at 4.6 percent with a modest 108,000 new jobs created, up slightly from the 92,000 jobs created in July.

In its latest snapshot of business conditions around the country, the Fed reported Wednesday that there were only limited reports that the turmoil in financial markets in August was having an adverse effect on business activity outside of real estate.

The revisions to productivity and labor costs had been expected given an upward revision announced last week to overall economic growth in the second quarter. The government said that the economy was growing at an annual rate of 4 percent in the April-June period, the best showing in more than a year and up from an initial estimate of 3.4 percent.

The increase in output pushed productivity higher and meant lower unit labor costs.

Separately, the Cleveland Federal Reserve issued a new study that said U.S. house prices may fall further as credit availability tightens.

"House prices may still fall in the future," wrote the researchers. "Any change in the ability to purchase a home, such as from innovations in the lending environment, can have a large impact on the level and volatility of housing prices."

The study went on to forecast that the boom-bust cycle of lending could crimp the ability of households with a weaker credit profile to borrow.

"Private mortgage originators have announced substantial changes to their subprime variable-rate mortgage programs, which are likely to result in the sharply curtailed availability of this type of credit," said the economists.

Home prices in the 20 biggest U.S. cities fell 2.8 percent from a year earlier in the second quarter, according to the Standard & Poor's/Case-Shiller Home Price Index.