By Lucia Mutikani
WASHINGTON, June 3 (Reuters) - U.S. services sector activity picked up in May as businesses preemptively placed orders and replenished inventories in anticipation of shortages and higher prices stemming from the war in the Middle East.
The Institute for Supply Management survey on Wednesday showed a measure of prices paid by services businesses increased to the highest level in nearly four years last month, with the cost of petroleum-related products reported to have risen, something
that the ISM said respondents had not mentioned in April.
The three-month U.S.-backed war with Iran has severely disrupted the supply of commodities and raised prices of goods including energy, aluminum and fertilizers. Comments from businesses in the ISM survey mostly highlighted inflation and emerging supply constraints.
"The largest part of the economy remains healthy and continues to expand, even as inflation pressures are intensifying," said Priscilla Thiagamoorthy, a senior economist at BMO Capital Markets. "That will likely keep Fed officials in wait-and-see mode."
The ISM's non-manufacturing purchasing managers index increased to 54.5 last month from 53.6 in April. Economists polled by Reuters had forecast the services PMI would be 53.8. A reading above 50 indicates growth in the services sector, which accounts for more than two-thirds of U.S. economic activity.
The rise in the services PMI mirrors an increase in manufacturing activity reported by the ISM this week.
Seventeen industries reported growth last month, including wholesale trade, construction, public administration, accommodation and food services as well as utilities and retail trade. Only real estate, rental and leasing reported contraction.
Some providers of educational services said they were "starting to see increased supply constraints and associated price increases, especially for construction materials and computers like laptops and tablets."
Accommodation and food services businesses said "suppliers across numerous industries are trying to pass price increases for fuel surcharges and increased input costs for resin-based products and the like," adding "we expect significant cost increases to impact us by late second quarter and definitely in the third quarter."
Wholesale trade businesses reported that "capital expenditure energy projects continue to be delayed or revamped based on macroeconomic factors." They also noted that "data center power generation projects are driving demand and reducing available inventory across the piping market."
INVENTORIES INCREASE SHARPLY
The survey measure of new orders received by services businesses jumped to 57.3 from 53.5 in April. A gauge of services sector inventories soared to 62.5, the highest reading since May 2010, from 53.1 in the prior month. Business inventories have been drawn down for four straight quarters, the longest such stretch since the Great Recession.
Steve Miller, chair of the ISM services business survey committee, said the jump in inventories was not concerning, noting that the inventory sentiment index only edged up by 0.1 percentage point. It "indicates respondent confidence that business activity will remain strong amid higher costs," he said.
Growth in backlog orders slowed, however, as did exports.
The survey's measure of prices paid by businesses for inputs increased to 71.3, the highest level since August 2022, from 70.7 in the prior month, an indication that the oil price shock would continue to spill over to the services sector.
Inflation increased at its fastest pace in three years in April, the government reported last week. The Federal Reserve is expected to hike its benchmark overnight interest rate, currently in the 3.50%-3.75% range, at its meeting in December, according to CME Group's FedWatch tool.
Stocks on Wall Street were trading lower after recent strong gains. The dollar advanced against a basket of currencies. U.S. Treasury yields largely rose.
The survey's measure of supplier deliveries eased to a still-high 55.2 from 56.8 in April. A reading above 50 indicates slower deliveries. The elevated reading likely contributed to the rise in the services PMI as the economy strengthens and demand increases. In this instance, however, strained supply chains are driving the rise in delivery times.
Computers, electronic components and memory components were among the goods that remained in short supply.
Services sector employment remained subdued, with the ISM saying companies were reporting hiring freezes or were not backfilling vacated positions. Separately on Wednesday, the ADP National Employment Report showed private employment increased by 122,000 jobs in May after a rise of 105,000 in April. Economists had forecast private employment would advance by 117,000 jobs.
Most economists view the labor market as stable after it wobbled last year amid uncertainty stemming from tariffs.
The ADP report is jointly developed with the Stanford Digital Economy Lab, and was published ahead of the release on Friday of the Bureau of Labor Statistics' more comprehensive and closely watched employment report. The ADP report has been a poor predictor of the BLS's private payrolls estimate.
The Labor Department's Job Openings and Labor Turnover Survey, or JOLTS report, on Tuesday showed hiring decreased and layoffs fell in April, suggesting the gain of 115,000 jobs in the nonfarm payrolls report in April was due to lower layoffs.
Payrolls likely rose by 85,000 jobs in May, a Reuters survey of economists predicted. The unemployment rate is forecast to have held steady at 4.3%.
"The indicators with a better track record of forecasting payrolls - the hiring intentions indexes of the NFIB and regional Fed surveys, as well as the job availability differential of the Conference Board's survey - have weakened in recent months," said Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics. "Evidence that the labor market is regaining momentum remains unconvincing."
(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama, Andrea Ricci and Paul Simao)
