US service sector expands in February; price growth accelerates

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. services sector growth unexpectedly picked up in February and prices for inputs increased, which combined with a recent surge in the cost of raw materials at factories suggested that inflation could heat up in the months ahead.

Rising price pressures could be worsened by a trade war, triggered by President Donald Trump's new 25% tariffs on imports from Mexico and Canada, which took effect on Tuesday, along with a doubling of duties on Chinese goods to 20%.

The Institute for Supply Management (ISM) said on Wednesday its nonmanufacturing purchasing managers index (PMI) climbed to 53.5 last month from 52.8 in January. Economists polled by Reuters had forecast the services PMI dipping to 52.6.

A PMI reading above 50 indicates growth in the services sector, which accounts for more than two-thirds of the economy. The ISM associates a PMI reading above 49 over time with expansion in the overall economy.

The PMI pointed to resilience in domestic demand, but was at odds with so-called hard data, including consumer spending and homebuilding that have suggested a sharp slowdown in gross domestic product this quarter.

With the goods trade deficit deteriorating sharply in January, largely blamed on front-loading of imports ahead of tariffs, the Atlanta Fed is currently forecasting GDP contracting at a 2.8% annualized rate this quarter. The economy grew at a 2.3% pace in the fourth quarter.

The ISM survey's new orders measure rose to 52.2 last month from 51.3 in January. That helped to lift its gauge of prices paid for services inputs to 62.6 from 60.4 in January. The ISM reported on Monday that its measure of prices paid by factories jumped to nearly a three-year high in February.

TARIFFS TO BOOST PRICES

The Trump administration's tariffs on Canadian, Mexican and Chinese goods are expected to raise prices for items as small as avocados to as big as motor vehicles.

Target CEO Brian Cornell told CNBC that the retail giant would increase prices "over the next couple of days" on some seasonal grocery products such as avocados from Mexico.

Economists at Nationwide estimated that tariffs against the nation's three major trade partners would increase the cost of goods per household by nearly $1,000 annually.

Consumer prices increased 3.0% year-on-year in January, the largest gain in seven months. Worries that tariffs would raise prices contributed to the Federal Reserve's decision to pause its interest rate cuts in January.

Suppliers' delivery performance slowed last month. The ISM survey's supplier deliveries index increased to 53.4 from 53.0 in January. A reading above 50 indicates slower deliveries.

That also contributed to the rise in the services PMI. A lengthening in suppliers' delivery times is normally associated with a strong economy, which would be a positive contribution to the PMI. But in this case slower supplier deliveries likely indicated bottlenecks in supply chains related to tariffs.

The survey's measure of services employment increased to 53.9 from 52.3 in January. It has not been a reliable predictor of services payrolls in the government's closely watched employment report, which is scheduled to be released on Friday.

Nonfarm payrolls likely increased by 160,000 jobs in February after rising 143,000 in January, a Reuters survey showed. The unemployment rate is forecast unchanged at 4.0%.

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama)