NEW YORK (Reuters) - Activity in the vast U.S. services sector slowed to a near two-year low in January, suggesting that economic growth weakened further at the start of the first quarter even as the labor market remains resilient.
The economy has been undermined by a strong dollar, softening global demand and an inventory destocking, which have pressured manufacturing and export industries. Spending cuts by energy firms, reeling from a collapse in oil prices, have also dragged on growth.
Until recently, services sector strength had offered hope that the economy would weather both the domestic and global headwinds, which held gross domestic product growth to a 0.7 percent annual rate in the fourth quarter.
"The slowdown in the services sector indicators may go a long way in fanning fears of a more pronounced slowdown to U.S. growth momentum heading into 2016," said Gennadiy Goldberg, an economist at TD Securities in New York.
The Institute for Supply Management (ISM) said its index of non-manufacturing activity fell to 53.5 last month, the lowest level since February 2014, from 55.8 in December.
A reading above 50 indicates expansion in the service sector, which accounts for more than two-thirds of the U.S. economy. Service industries reported growth in new orders continued to slow, with export orders contracting last month.
The ISM noted that while the majority of the respondents' comments were positive about business conditions, there were concerns about the global environment, stock market volatility and their impact on commercial and consumer confidence.
Food industries complained about the dollar's strength and wholesalers said the plunge in oil prices was putting "extreme pressure" on exchange rates in key export markets. As a result, companies were forced to cut prices to beat competition, which was compressing margins.
Oil prices have plunged about 70 percent in the last 18 months, hit by a growing glut and cooling economic growth in China and other emerging markets. The dollar has gained 22.2 percent against the currencies of the United States' main trading partners since June 2014.
WEAKNESS SPREADING
A separate survey from data firm Markit also showed moderating services sector activity last month. Markit's U.S. services business activity index fell to 53.2, the lowest level since October 2013, from 54.3 in December. Though still above the key 50 mark, January's reading was also below the average recorded since the survey began in October 2009.
The reports join a raft a weak data ranging from inflation to manufacturing and consumer spending in suggesting the Federal Reserve will probably not hike interest rates in March. The U.S. central bank raised its benchmark overnight lending rate in December for the first time in nearly a decade.
The dollar fell to a more than seven-week low against a basket of currencies and U.S. stocks were trading lower. Prices for U.S. government debt fell marginally.
"There are more uncertainties out there and that is likely to cause the Fed to be cautious in their drive to normalize," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.
With business activity cooling, the ISM survey's employment index fell to a one-year low in January. While this raises the possibility that employment growth slowed in January after non-farm payrolls surged 292,000 in December, there are signs that the labor market remains fairly strong.
In a separate report, payrolls processor ADP said private employment increased 205,000 in January. December's private payroll gains were revised up to 267,000 from 257,000.
The ADP National Employment Report, which is jointly developed with Moody's Analytics, came ahead of the U.S. Labor Department's more comprehensive employment report on Friday, which includes both public and private-sector employment.
Economists polled by Reuters are looking for total non-farm payrolls to increase by 190,000 in January and the unemployment rate to remain at a 7-1/2-year low of 5 percent.
Private hiring fell below December's brisk pace because of a slowdown at the largest companies, which more sensitive to current economic conditions than small and mid-sized firms, ADP said.