U.S. Service Sector Cools in March, Iran War Escalates Inflation Pressure

U.S. service sector growth slowed in March, and the prices of inputs paid for by businesses climbed to near a 3.5-year high, an early sign that the prolonged war with Iran is intensifying inflation pressures.

The Institute for Supply Management said Monday that its non-manufacturing purchasing managers’ index slipped from 56.1 in February to 54.0 last month. Economists polled by Reuters expected the services PMI to fall to 54.9. Services account for more than two-thirds of U.S. economic activity, and a reading above 50 indicates services growth.

The conflict between the U.S. and Iran has entered its second month, and global oil prices are up more than 50%. The nationwide average retail gasoline price has for the first time in more than three years exceeded $4 per gallon. Economists expect the war’s impact on inflation to show up in the March consumer price index report to be released on Friday.

Producer prices have already risen in February, as markets expect the Middle East conflict to escalate.

The ISM survey’s index of input prices paid by businesses surged from 63.0 in February to 70.7, the highest since October 2022.

The index has stayed elevated, with firms blaming higher costs on the broad tariffs imposed by President Trump, but the U.S. Supreme Court has rejected those tariffs. Trump’s response, however, is to implement a package of global tariffs lasting 150 days.

The survey’s measure of supplier deliveries rose from 53.9 in February to 56.2. Readings above 50 indicate slower delivery speeds. That reflects longer factory lead times, with food, beverage and tobacco product makers calling it “container delays.”

The expected inflationary fallout from the conflict has greatly reduced the likelihood of rate cuts this year. The Federal Reserve held its benchmark overnight interest rate in the range of 3.50% to 3.75% last month.

The survey showed that the new orders index rose from 58.6 in February to 60.6, the highest in two years. But growth in export orders slowed sharply, and the increase in backlogs also eased.

Service sector employment contracted, with the employment index falling to its lowest level since December 2023. That contrasts with a sharp rebound in job growth in March, which was driven by private service sector payroll growth of 143k. However, the ISM employment index does not forecast well the level of private service sector payrolls in the Labor Department’s jobs report.

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