Robust Service Sector Keeps Fed Rate Hike in Play

By Lucia Mutikani

WASHINGTON -- Private job growth slowed in July, but a surge in service-industry activity to a near-decade high suggested solid economic momentum that strengthens the case for a Federal Reserve interest rate hike this year.

The firm domestic fundamentals were underscored by another report Wednesday showing an increase in imports of food, automobiles, industrial supplies and consumer goods in June.

%VIRTUAL-pullquote-This will be interpreted as very good news for the Fed and will be seen as further confirmation of progress towards meeting its growth targets.%"This will be interpreted as very good news for the Fed and will be seen as further confirmation of progress towards meeting its growth targets. At this point, we continue to expect the Fed to raise rates at the September meeting," said Cheng Chen, an economist at TD Securities in New York.

The Institute for Supply Management said its service-sector index jumped to 60.3 last month, the highest reading since August 2005, from 56 in June. A reading above 50 indicates expansion in the services sector, which accounts for more than a third of the U.S. economy.

The index was buoyed by a 5.5 percent increase in the new orders gauge, which also hit its highest level since August 2005. A measure of service industry employment soared 6.9 percent to its highest reading in a decade. Fifteen services industries reported expansion last month, while mining and one other saw a contraction in production.

The ISM survey, however, likely overstates the services sector expansion. Another survey from data firm Markit showed the sector growing moderately in July.

Still, the services sector is helping to offset the drag on the economy from weak manufacturing.

The jump in service sector employment in July also eased concerns Wednesday of a sharp slowdown in job growth after the ADP National Employment Report showed private employers hired only 185,000 workers last month. Economists had expected a gain of 215,000.

The report, which is jointly developed with Moody's Analytics, came ahead of the U.S. government's more comprehensive employment report on Friday. It is, however, not considered a good predictor of nonfarm payrolls.

Prices for U.S. Treasury debt fell, while U.S. stocks edged higher. The dollar was slightly firmer against a basket of currencies.

'Approaching Full Employment'

According to a Reuters survey of economists, nonfarm payrolls likely increased 223,000 last month, matching June's job gains. Job cuts in the energy sector in the aftermath of the sharp drop in crude oil prices have take some edge off the labor market in recent months.

"Nonetheless, even at this slower pace of growth, the labor market is fast approaching full employment," said Mark Zandi, chief economist at Moody's Analytics in West Chester, Pennsylvania.

The Fed has kept its short-term interest rate near zero since December 2008. A report last week showing wage growth stalled in the second quarter cast doubt that the U.S. central bank would hike rates at its September policy meeting.

In a separate report Wednesday, the Commerce Department said the U.S. trade deficit increased 7.1 percent to $43.8 billion in June.

%VIRTUAL-WSSCourseInline-876%But May's trade gap was revised down by $1 billion to $40.9 billion, leading economists to expect that the second-quarter gross domestic product estimate would be revised up from the 2.3 percent annual pace the government reported last week.

May construction and factory inventory data released this week also have suggested second-quarter growth could be revised to at least a 3 percent annual rate when the government publishes its second GDP estimate later this month.

June's trade deficit was driven by a 1.2 percent rise in imports, as domestic demand grew solidly in the second quarter. The dollar, which has gained 15 percent against the currencies of the United States' main trading partners since June 2014, is also making imports cheaper.

Despite firming domestic demand, some of the imports likely ended up in inventories, which remained at very high levels in the second quarter. That would act as drag on third-quarter growth.

Imports of food and automobiles were the highest on record in June. Dollar strength and sluggish global demand crimped exports, which slipped 0.1 percent in June. It was the second straight monthly drop in exports.

Imports from the European Union surged 4 percent to a record high, leaving the trade deficit with the EU at an all-time high.

Though exports to Mexico rose solidly, they were outpaced by a jump in imports, putting the trade deficit with that country at the highest level since May 2012. The politically sensitive U.S.-China trade deficit rose 3.3 percent to $31.5 billion.

-Richard Leong and David Gaffen contributed reporting from New York.