U.S. Service Sector Accelerates, Inflation Pressures Prompt Fed Rate‑Hike Speculation

The U.S. services industry is showing a robust uptick, with the Institute for Supply Management’s (ISM) Business Activity Index climbing to 61.7 in August from 59.1 in July. The surge is largely driven by a surge in new orders, which rose to 60.9 – the strongest reading since February 2023.

Key tailwinds include tariff refunds, a general improvement in business conditions, and easing wage pressures. Despite these positives, tariffs remain a prominent supply‑chain headache, according to the ISM.

Economists anticipate that services will continue to be the main engine of growth in the coming quarter, helping to cushion the impact of a widening trade deficit, which expanded to $88.6 billion in July from $71.2 billion in June.

Inventories are also poised to play a pivotal role in a third‑quarter rebound. The Atlanta Fed’s GDPNow model, released on September 1, projects a 4.8 % growth rate. In August, the ISM Inventories Index rose to 56.7 from 51.4, indicating a faster accumulation.

However, price pressures are on the rise. The ISM Prices Index climbed to 72.6 in August from 70.3 in July, reflecting the combined effect of stronger demand and higher input costs. These dynamics keep inflation concerns at the forefront of policy discussions.

Market participants are now pricing in roughly even odds that the Federal Reserve will raise rates by 25 basis points in September. Even though the ISM manufacturing and services data are considered soft, the persistent price pressure may compel the Fed to act.

With the economy still expanding at a solid pace, the Fed’s focus has shifted toward price stability. From now until the September 15‑16 meeting, inflation metrics – especially the Consumer Price Index (CPI) and Producer Price Index (PPI) – will be the primary determinants of whether policymakers raise or hold rates.

The ISM service index’s modest decline to 55.3 in June – the slowest growth level in more than two years, since May 2020’s 45.2 – underscores the delicate balance. Yet the August uptick, buoyed by a surge in summer spending, signals that the services sector remains resilient.

In sum, the latest data suggest that the Federal Reserve is unlikely to rush into rate cuts this year, as inflationary pressures continue to loom over the economic landscape.