WASHINGTON (Reuters) - The U.S. services industry slowed less than expected in June, but a measure of services employment dropped to a two-year low, suggesting that demand for labor could be ebbing as the Federal Reserve's aggressive monetary policy stance leaves the economy staring at a recession.
The Institute for Supply Management said on Wednesday its non-manufacturing activity index slipped to 55.3 last month from a reading of 55.9 in May. The third straight monthly decline pushed the index to its lowest level since May 2020, when the economy was battling the initial wave of the COVID-19 pandemic.
Economists polled by Reuters had forecast the non-manufacturing index decreasing to 54.3. A reading above 50 indicates expansion in the services sector, which accounts for more than two-thirds of U.S. economic activity.
The sector is being underpinned by a rotation in spending back to services from goods. The moderation in growth is in line with recent data showing rising interest rates cooling demand. Consumer spending rose modestly in May, while housing starts, building permits and factory output softened.
The ISM reported last Friday that its national factory activity index hit a two-year low in June.
The Fed last month raised its policy rate by three-quarters of a percentage point, its biggest hike since 1994, to quell inflation. Another similar sized rate hike is expected in July. The U.S. central bank has increased its benchmark overnight interest rate by 150 basis points since March, leaving the economy on a recession watch.
Gross domestic product already contracted in the first quarter, and the recent run of soft data has left some economists anticipating that output declined further last quarter. But another decline in GDP would not necessarily indicate a recession unless the economy suffers steep job losses.
The ISM's measure of new orders received by services businesses fell to a still-high reading of 55.6 last month from 57.6 in May. Businesses reported a surge in order backlogs, while exports continued to grow.
But its services industry employment gauge dropped to 47.4, the lowest reading since July 2020, from 50.2 in May. It was the third time this year that the index has dropped below 50. June's decline could be either a sign of slowing demand for labor or persistent worker shortages. The ISM's factory employment gauge also fell into recession territory in June.
At face value, this does not bode well for the Labor Department's employment report for June due on Friday. But job growth remained solid in the months that the ISM employment measures contracted. There were 11.4 million job openings at the end of April.
The ISM survey's measure of supplier deliveries inched up to 61.9 from 61.3 in May. Though services inflation continued to run hot, there are signs that it has probably peaked. A measure of prices paid by services industries for inputs fell to 80.1, the lowest reading since September 2021, from 82.1 in May.
With demand for goods cooling, services sector prices are key to how soon inflation could start trending lower.
(Reporting By Lucia Mutikani; Editing by Chizu Nomiyama)