US service sector rebounds, but inflation fears clouds outlook

The US services sector regained momentum in May, expanding at a faster pace and defying expectations of a prolonged slowdown, even as tariffs and supply delays continued to exert upward pressure on costs.

According to S&P Global’s latest Purchasing Managers’ Index (PMI) data, the Services PMI rose to 53.7 in May from April’s 50.8, comfortably above the 50-mark that separates growth from contraction marked the 28th consecutive month of expansion. The reading also surpassed the preliminary 'flash' estimate of 52.3.

The uptick was driven by concurrent increases in business activity and new orders, as firms benefited from a more stable domestic demand environment. However, foreign demand remained subdued for a second straight month amid ongoing global trade uncertainties, particularly around tariffs.

Tariffs drive up costs, but optimism rebounds

While service firms added staff to handle growing workloads, the rise in employment wasn’t sufficient to clear backlogs, which grew at the fastest pace since last November. Tariffs-linked equipment delivery delays were cited as a key factor behind rising work outstanding.

Tariffs also contributed to a sharp rise in input cost inflation, which surged to its highest level since June 2023. Businesses faced steeper wage bills and elevated supplier prices, forcing many to pass on the costs to clients. As a result, output charge inflation hit its steepest level since August 2022.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, noted that while the service sector is showing signs of recovery, inflationary pressures remain a critical concern. “These rising price pressures will only add to policymaker reluctance to reduce interest rates, which we consequently expect to remain on hold until December,” he said.

Despite the cost burdens, business confidence improved in May, buoyed by tariff pauses and expectations of a more predictable policy environment. Optimism about the year ahead reached a four-month high, though it still lags behind historical averages. Companies are planning increased marketing and facility expansion as part of their growth outlook.

Composite outlook mixed amid manufacturing weakness

The broader US economy saw a modest improvement in May, with the S&P Global Composite PMI rising to 53.0 from 50.6 in April. However, the services-led rebound masked continued struggles in the manufacturing sector, which contracted for the third consecutive month.

The ISM’s separate manufacturing PMI fell to 48.5 in May, its lowest in six months, reflecting persistent weakness. Factories reported declining new orders, worsening supply chain bottlenecks, and ongoing job losses.

The effects of tariffs were also evident, with slower deliveries and falling import volumes signaling pressure on the goods-producing sector.

Economists warn that while the US economy is avoiding recession for now, growth remains fragile. “The PMI is so far indicating annualized GDP growth barely above 1 per cent in the second quarter,” Williamson said, forecasting modest 1.3 per cent growth for 2025.

With inflationary risks rising and manufacturing under strain, the Federal Reserve is expected to hold rates steady through year-end as it monitors evolving macroeconomic dynamics.