Service Sector Growth Slips; Factory Orders Jump

Growth in the U.S. service sector slipped in November to its lowest since March, showing some parts of the economy were feeling the strain of upheaval in credit markets and the lingering housing downturn, according to a report released Wednesday.

But other reports showed surprisingly strong growth. New orders at U.S. factories posted a surprisingly strong 0.5 percent increase in October, helped by more demand for defense and transportation equipment, and also were revised up for September in a Commerce Department report issued on Wednesday.

Separately, another government report showed U.S. worker productivity in the third quarter notched the strongest growth in four years on a cut-back in hours that curbed labor costs.

The Institute for Supply Management's services index fell to 54.1 last month from 55.8 in October, below economists' median forecast for a slip to 55.0.

The dividing line between growth and contraction is 50. The services sector represents about 80 percent of U.S. economic activity, including businesses such as banks, airlines, hotels and restaurants.

The new orders component slipped to 51.1 in November from 55.7 in October, the lowest since April 2003. The prices paid index, a gauge of inflation pressures, jumped to 76.5 from 63.5. The employment index slipped to 50.8 from 51.8. "I wouldn't make much of (this) drop ... It's not out of line with the ISM manufacturing index (released Monday)," said Cary Leahey, economist with Decision Economics in New York.

However he added: "You do have some signs of stagflation: a jump in prices paid, but a slowdown in orders and employment. The index is telling you that the economy is probably growing at about a 2 percent rate right now."

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

Factory Orders Rise

Meanwhile, Wall Street economists surveyed by Reuters had forecast that October factory orders would be flat. Instead, not only were they up but the government said that September orders increased by a slightly stronger 0.3 percent rather than the 0.2 percent gain it estimated a month ago.

The October orders rise was the strongest since a 3.4 percent jump in July.

Excluding transportation, factory orders rose 0.6 percent in October. When defense orders were stripped out, factory orders were up 0.3 percent.

Non-defense capital goods order excluding aircraft, a proxy for business spending, fell a revised 2 percent in October after rising 1.4 in September.

Last week, the government had said in a report on durable goods orders that non-defense capital goods orders excluding transportation had fallen more steeply by 2.3 percent in October.

Orders for transportation goods were up 0.5 percent in October, although that followed a 6.9 percent plunge in September. Defense capital goods orders climbed strongly by 16 percent, partly reversing September's 26.8 percent drop.

Good News: Inflation

Good News for Inflation Concerns

Earlier, a report on U.S. nonfarm productivity, or hourly output per worker, rose at a 6.3 percent annualized pace in the third quarter, in news that will help the Federal Reserve set lingering inflation-concerns aside.

It was the largest increase in productivity since the third quarter of 2003, when it increased at 10.4 percent rate, according to the Labor Department Report.

Economists polled by Reuters expected nonfarm worker productivity to be revised up 5.7 percent, compared with the 4.9 percent annualized pace initially recorded.

Unit labor costs, a gauge of inflation and profit pressures under close scrutiny by the Fed, was revised to show a 2.0 percent drop in the third quarter for the largest decline in four years. These had been forecast to decline by 1.0 percent, from an initially reported 0.2 percent fall.

It was the second consecutive quarter of declining labor costs. A Labor Department official said the last time the U.S. economy experienced two straight quarters of falling unit labor costs was in the first six months of 1996.

The total number of hours worked shrank 0.6 percent compared with a 0.5 percent drop previously reported. The last time it dropped by more than this amount was the April to June period of 2003, when hours declined by 1.3 percent.

Expectations for the Fed

Investors expect the Fed to cut rates by at least a quarter percentage point to 4.25 percent at their next meeting on Dec. 11. Policymakers worry that a deepening housing downturn could harm the wider economy, but are also concerned about the impact of rising energy and food prices on inflation.

The Fed monitors productivity, a measure of how much any given worker can produce in an hour, for clues on whether cyclical swings in the business cycle are pressuring inflation, as well as for signals on longer term structural trends.

Weaker productivity amid tight labor markets can spell wage-push inflation. But faster productivity growth may help the economy expand without sparking wage-push inflation.

Year-on-year, productivity grew 2.7 percent in the third quarter, up from 2.4 percent preliminarily reported, the Labor Department data showed. This helped subdue yearly unit labor cost growth to 3.0 percent, versus the 4.3 percent gain that was initially thought.

Underlying productivity performance over a period of years shapes the economy's long-term growth potential, which policymakers estimate for a sense of how fast the economy can grow without sparking price pressures.