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US service sector grows at fastest pace in 3 years, but tariff concerns increase

The U.S. service sector expanded at its fastest pace since April 2015 due to more favorable economic conditions and greater client demand, but businesses are increasingly concerned about the impact of tariffs, IHS Markit reported.

The final IHS Markit U.S. services business activity index for May came in at a seasonally adjusted reading of 56.8, up from 54.6 in April. The initial reading was 55.7.

"Increased marketing activity and customer interest was successfully converted to client wins in May, with new business levels rising at a steep pace," the IHS Markit report said.

In addition to growth in business activity and new orders, service sector firms also boosted their hiring in May. IHS Markit said the growth in staffing levels last month was the strongest since September 2015.

IHS Markit chief business economist Chris Williamson said the service sector growth momentum is likely to me sustained in the coming months, with business optimism at one of the highest levels seen over the past three years.

However, concerns over rising costs and the impact of tariffs have also increased, Williamson said.

"Across both manufacturing and services, companies' costs are now rising at one of the strongest rates seen over the past seven years, which will likely feed through to higher consumer prices in coming months," he said.

In May, input cost inflation rose at its fastest pace since October 2013. "Anecdotal evidence suggested the latest rise in cost burdens was due to higher material inputs, often linked to tariffs, higher interest rates and rising energy and fuel prices," the report said.

Another survey that measures the health of the U.S. service sector also showed faster growth in May along with lingering worries over tariffs.

The Institute of Supply Management's non-manufacturing index rose to 58.6% from 56.8% in April, with 14 industries reporting growth. A reading above 50% indicates expansion.

"The majority of respondents are optimistic about business conditions and the overall economy. There continue to be concerns about the uncertainty surrounding tariffs, trade agreements and the impact on cost of goods sold," said Anthony Nieves, chair of the ISM non-manufacturing business survey committee.

The prices index increased to 64.3% in May from 61.8% in the previous month, indicating that prices went up for the 27th consecutive month.

The non-manufacturing business activity index rose to 61.3% from 59.1%; the new orders index edged up to 60.5% from 60%; and the employment index increased rose to 54.1% from 53.6%.