(July 24): US business activity slowed to a five-month low in July, dragged down by decelerating service-sector growth, closely watched survey data on Monday (July 24) showed, but falling input prices and slowed hiring indicate the Federal Reserve could be making progress on important fronts in its bid to reduce inflation.

S&P Global said its flash US Composite PMI index, which tracks manufacturing and service sectors, fell to a reading of 52 in July from 53.2 in June. July's reading showed the sixth straight month of growth but was restrained by softening conditions in the service sector. Readings above 50 indicate expansion.

Monday's tepid survey data supported evidence that the US economy was still growing as the third quarter began, but at a slower rate from the April-through-June period.

“The overall rate of output growth, measured across manufacturing and services, is consistent with GDP expanding at an annualised quarterly rate of approximately 1.5% at the start of the third quarter. That's down from a 2% pace signalled by the survey in the second quarter," said Chris Williamson, chief business economist at S&P Global Market Intelligence.

The slowdown may be viewed positively at the Fed, which is keen to see activity cool to lower inflation. On Wednesday policymakers are expected to raise interest rates by a quarter percentage point, to between 5.25% and 5.5%, in what many investors and economists see as potentially their last increase of the current cycle.

Overall, GDP is still heavily reliant on growth in the service sector as manufacturing contracts, but the report showed an increasing dependence on international demand as new export orders for services reached the highest levels since May 2022. The increase in foreign demand was due to a weakening US dollar.

The services activity index fell to 52.4 from 54.4 in June and was weaker than the reading of 54 expected among economists in a Reuters poll.

The survey's manufacturing output index, meanwhile, experienced growth for the first time in two months, rising to 50.2 from a contracting rate of 46.9 in June. The broader manufacturing PMI index was improved but still in contraction territory at 49 versus 46.3 last month and topped economists' forecast for 46.2.

Mixed outlook

There were several signs in the report that suggested the Fed's interest rate hikes might be making progress towards taming inflation that remains well above its 2% target.

Firms in manufacturing and services both increased workforce headcount in July, but the combined rate of job creation was at a six-month low, suggesting a cooling in an otherwise resilient job market.

Meanwhile, increases in total input prices softened to the lowest levels since October 2020, but masked a split across industries: While the service sector also experienced the lowest cost pressures in over two-and-a-half years, inputs in manufacturing rebounded to a three-month high.

Domestic demand was subdued as new orders weakened for the second straight month.

Williamson said optimism in the private sector is faltering: The overall future outlook fell to the lowest levels since December 2022.

“The darkening picture adds downside risks to output growth in the coming months which, alongside the slowing in the pace of expansion in July, will keep alive fear that the US economy may yet succumb to another downturn before the year is out," said Williamson.