U.S. Service Sector Contracts 1.7 Points Amid Tariff Impact

The U.S. service sector experienced its first contraction in nearly a year, with demand plummeting and prices accelerating due to the impact of tariff increases on the broader economy. The service sector index dropped 1.7 points to 49.9 in May, marking the first time the index has fallen below the 50-point threshold, indicating contraction, since June 2024. This decline was largely driven by a significant decrease in new orders, which fell 5.9 points to 46.4, the largest decline since June 2024. The business activity index also slid 3.7 points to 50, the lowest level in five years, further highlighting the slowdown in demand and business activity within the service sector.

In addition to the contraction in demand, service sector businesses are also facing rising costs. The input price index surged to 68.7, the highest level since November 2022, indicating that businesses are paying more for inputs. This increase in input prices is likely to exacerbate inflationary pressures, as businesses pass on higher costs to consumers. The deterioration in supplier delivery performance and extended factory lead times further indicate supply chain tensions, which could contribute to rising inflation.

The sudden contraction in the service sector and the surge in input prices raise concerns about the broader economic outlook. The combination of declining demand and rising costs could lead to a slowdown in economic growth, as businesses and consumers alike face increased financial strain. The impact of tariffs on inflation and employment is expected to become more apparent in the coming months, as the effects of recent policy changes ripple through the economy. The overall index did not indicate severe contraction but rather reflected the uncertainty felt by businesses surveyed by the Institute for Supply Management (ISM). These businesses continue to face challenges in forecasting and planning due to the ongoing uncertainty surrounding tariffs and the frequent mention of delaying or reducing orders until the situation becomes clearer.

The decline in the service sector index was accompanied by a decrease in the backlog of orders, which reached its lowest level since August 2023. This further indicates a slowdown in demand within the service sector. The combination of declining demand and rising costs could lead to a slowdown in economic growth, as businesses and consumers alike face increased financial strain. The impact of tariffs on inflation and employment is expected to become more apparent in the coming months, as the effects of recent policy changes ripple through the economy. The overall index did not indicate severe contraction but rather reflected the uncertainty felt by businesses surveyed by the Institute for Supply Management (ISM). These businesses continue to face challenges in forecasting and planning due to the ongoing uncertainty surrounding tariffs and the frequent mention of delaying or reducing orders until the situation becomes clearer.