The United States services sector expanded at a faster pace in May as businesses increased orders and replenished inventories in anticipation of supply shortages and higher costs linked to the ongoing conflict in the Middle East.
Data released by the Institute for Supply Management (ISM) on Wednesday showed the non-manufacturing purchasing managers' index (PMI) rose to 54.5 in May from 53.6 in April, exceeding market expectations of 53.8.
A reading above 50 indicates expansion in the services sector, which accounts for more than two-thirds of U.S. economic activity.
The stronger reading reflected growing business activity as companies moved to secure supplies amid concerns that disruptions caused by the U.S.-Israel war with Iran could further strain commodity markets and increase costs across the economy.
The conflict has significantly disrupted supplies of key commodities and contributed to higher prices for energy, aluminium and fertilisers, adding to inflationary pressures already evident throughout the economy.
That trend was reinforced by the Federal Reserve's latest Beige Book report, which noted that prices increased at a "moderate to strong pace overall" during May.
The report added that "energy-related costs tied to the conflict in the Middle East were the primary driver of inflationary pressures, with spillovers into shipping, packaging, groceries, and fertiliser".
The increase in services activity followed a similar improvement in manufacturing reported earlier this week, suggesting broad-based resilience across the U.S. economy despite rising costs and geopolitical uncertainty.
Seventeen industries reported growth during May, including wholesale trade, construction, public administration, accommodation and food services, utilities and retail trade.
Real estate, rental and leasing was the only sector to report contraction.
However, business commentaries within the survey noted mounting concerns about inflation and supply chain pressures.
Businesses in the accommodation and food services sector noted: “We are seeing the dual effects of the administration’s tariff policy dynamics and the conflict in the Persian Gulf affect our pricing.
"Suppliers across numerous industries are trying to pass price increases for fuel surcharges and increased input costs for resin-based products and the like.
"This is the definition of inflationary pressure starting to affect us. We expect significant cost increases to impact us by late second quarter (Q2) and definitely in Q3.”
Meanwhile, providers of educational services reported they were "starting to see increased supply constraints and associated price increases, especially for construction materials and computers like laptops and tablets".
Wholesale trade firms also pointed to delays in energy-related projects, stating: “Capital expenditure energy projects continue to be delayed or revamped based on macroeconomic factors.
"Data centre power generation projects are driving demand and reducing available inventory across the piping market.”
The survey showed new orders strengthened considerably, with the index rising to 57.3 from 53.5 in April.
Inventories increased sharply, with the services inventories index surging to 62.5 from 53.1, marking its highest level since May 2010 as businesses sought to build stockpiles ahead of potential shortages.
Steve Miller, chair of the ISM services business survey committee, said the inventory build-up did not appear excessive.
“Despite the 9.4-percentage point increase in the Inventories Index compared to April, a 0.1 percentage point increase in the Inventory Sentiment Index indicates respondent confidence that business activity will remain strong amid higher costs, so expanding inventories are not of concern.”
Inflation concerns remained a key feature of the report. The prices paid index increased to 71.3 in May from 70.7 in April, reaching its highest level since August 2022 and signalling that higher oil prices are continuing to spread through the broader economy.
The rise follows government data released last week showing inflation accelerated at its fastest annual pace in three years during April.
Supplier delivery times remained elevated, although they eased slightly. The supplier deliveries index fell to 55.2 from 56.8 in April. A reading above 50 indicates slower deliveries.
While rising demand can contribute to longer delivery times, the ISM suggested strained supply chains were playing a significant role in the latest increase. Businesses reported ongoing shortages of computers, electronic components and memory products.
Employment conditions in the services sector remained subdued. The ISM said many businesses continued to implement hiring freezes or were choosing not to replace departing workers.
Additional evidence of labour market resilience came from the Labor Department's Job Openings and Labor Turnover Survey (JOLTS), released on Tuesday, which showed hiring declined and layoffs fell in April.
The data suggested the increase of 115,000 jobs recorded in April's nonfarm payrolls report was largely driven by fewer workers losing their jobs rather than a surge in hiring.
