Services Sector Slows Amid Weak Demand and Inflation Pressure
Weekly Economic Review: August 11, 2025
This week’s economic data includes: (1) ISM Report on Business Services Sector and (2) initial jobless and continuing claims.
Key Summary:
The service sector experienced an unexpected slowdown in July, with minimal growth driven by weakening demand, near-stagnant new orders, contracting employment, and persistent inflationary pressures.
The U.S. service sector showed signs of slowing in July, with overall activity hovering just above the line between growth and contraction. The pace of expansion weakened compared to the previous month, driven largely by softening demand. While the sector did not contract, the data suggests it is approaching a point of stagnation, raising concerns about momentum in the broader economy.
Key components of the report represented mixed signals. Business activity and new orders continued to expand, but at a slower pace, with new orders nearing stagnation. Employment declined further into contraction territory, consistent with broader labor market weakness. Fewer industries reported growth, and several – including accommodation and food services – experienced contraction.
Inflationary pressures persisted, as service organizations faced rising costs for materials and services, with price levels reaching their highest point in nearly two years. Supplier delivery times lengthened. Meanwhile, backlogs continued to shrink, and inventory levels dipped slightly, suggesting cautious business sentiment.
Initial and continuing jobless claims rose, signaling a softening labor market in line with last week’s low job creation, as businesses remain cautious about both hiring and layoffs. Unemployed workers appear to face increasing difficulty finding new jobs.
Initial jobless claims rose modestly in the latest report, slightly above market expectations, but the overall trend remains stable. Claims have fluctuated within a narrow range for several weeks, and the four-week moving average has barely changed. This suggests that while hiring may be slowing, businesses are not engaging in widespread layoffs. The labor market continues to show signs of caution, with employers hesitant to make significant changes to their workforce amid softer economic conditions.
Meanwhile, continuing claims—representing those still receiving unemployment benefits—have increased to their highest level in nearly four years. This rise indicates that unemployed individuals are finding it more difficult to secure new jobs, pointing to a gradual weakening of labor market dynamics. Overall, the data reflects a low-turnover environment, with both hiring and firing activity subdued as businesses navigate economic uncertainty.
Let’s take a closer look at this week’s key data releases, including the ISM Services Report and the latest figures on initial and continuing jobless claims.
ISM Report on Business Services Sectors – July Update:
The Institute of Supply Management (ISM) released its July report on economic activity in the service sector, which represents approximately 70% of the private economy both in terms of employment and GDP. The ISM Services Index registered 50.1 in July, down 0.7 points from June’s reading of 50.8 and below market expectations of 51.5. A reading above 50 indicates growth in the service sector. July’s figure suggests a slower pace of expansion compared to the previous month and points to unexpected stagnation, primarily driven by weakening demand.
Business activity, which reflects services output comparable to factory production, declined to 52.6 from June’s 54.2, signaling continued growth but at a decelerating rate. Nine industries reported growth in July – two fewer than in June – led by wholesale trade. Meanwhile, five industries contracted, with accommodation & food services leading the decline.
Prices paid by service organizations for materials and services rose to 67.5 in July, a 2.4-point increase from June’s 65.1 and above market expectations of 66.5. This marks the highest level since the 70.7 reported for October 2022, underscoring persistent inflationary pressures largely attributed to increased costs from tariffs. Fifteen of the 18 service industries reported higher prices, led by wholesale trade.
New orders, a key forward-looking indicator, fell by 1 point to 50.2 in July from 51.3 in June. While the index still signaled expansion, the July reading approached stagnation, indicating growth at a notably slower pace.
Employment declined further into contraction territory, falling to 46.4 in July from 47.2 in June—its second consecutive monthly decline and the fourth in the past five months. This drop aligns with last week’s weak labor market data, and reflects reduced hiring activity and challenges in filling open positions.
The backlog of orders remained in contraction for the fifth straight month, but improved slightly to 44.3 in July from 42.4 in June. Inventories declined to 51.8 from 52.7, while supplier deliveries rose to 51.0 from 50.3, marking the eighth consecutive month of slower delivery performance. A reading above 50 indicates longer delivery times.
Jobless Claims – Week Ending August 2:
The Labor Department released the weekly initial jobless claims, which is the most timely data on the economy’s health. For the week ending August 2, new claims rose by 7,000 to 226,000, up from 219,000 (revised up from 218,000) in the previous week. This figure exceeded market expectations of 222,000 and reached the highest level since the week ending July 4, 2025.
The new claims tend to be volatile and have fluctuated within a narrow range of plus/minus 10,000 for ten consecutive weeks. The four-week moving average was virtually unchanged at 220,750 from 221,250 (revised up from 221,000) in the previous week.
The data suggests that businesses are not engaging in significant layoffs. However, recent reports on job creation indicate a slowdown in hiring activity. While economic growth has moderated and consumer spending has softened, employers appear to be exercising caution in both hiring and firing. This points to a labor market characterized by low turnover—both in terms of hiring and layoffs.
Continuing claims, which serve as a proxy for the total number of individuals receiving unemployment benefits, rose by 38,000 to 1.974 million for the week ending July 26. This is up from a revised 1.936 million (previously 1.946 million) and represents the highest level since November 5, 2021, when continuing claims stood at 2.041 million. The increase suggests that unemployed workers are facing greater difficulty finding new employment, signaling a potential softening in labor market conditions.
Market Analysis:
Equity markets ended the week with solid gains, driven by strong tech sector earnings, better-than-expected corporate results, and rising expectations for a Federal Reserve rate cut in September despite ongoing concerns about the impact of tariffs on inflation. The S&P 500 rose 2.4%, closing near its all-time high. The Dow Jones Industrial Average gained 1.3%, while the Nasdaq surged 3.9% to a record high. The Russell 2000, representing small-cap stocks, also advanced 2.4% for the week.
Treasury yields rose over the week, with the exception of very short-term maturities of under one year. The increase was primarily driven by concerns over the economic impact of reciprocal tariffs that took effect on Thursday, along with soft demand at recent Treasury auctions. This followed a sharp decline in yields the previous week, which was largely attributed to a weaker-than-expected July jobs report. By the end of the week, yields on the 2-year, 5-year, and 10-year notes rose by 7, 7, and 4 basis points, respectively, closing at 3.76%, 3.84%, and 4.27%.
Markets are currently pricing in two quarter-point rate cuts in 2025, totaling a 0.50% reduction. The first cut is expected in either September, with an 89% probability, or October, with a 100% probability. A second cut is anticipated in December, also with a 100% probability. Looking further ahead, markets are projecting three additional cuts by December 2026.
Next Week’s Economic Calendar:
The economic calendar is relatively full next week. It kicks off on Tuesday with the release of the NFIB Small Business Optimism Index and the Consumer Price Index (CPI). The CPI is expected to rise by 0.2% in July and 2.8% year-over-year, which would mark the third consecutive annual increase and the highest annual increase in five months. The core CPI is projected to rise by 0.3% in July and 3.0% year-over-year, which would represent the highest annual gain since February.
On Wednesday, weekly mortgage application data will be released, followed by the Producer Price Index (PPI) on Thursday. Like the CPI, both the headline and core PPI for July are expected to show month-over-month and year-over-year increases. Also on Thursday, weekly jobless claims will be reported. The week concludes on Friday with the release of July retail sales, which are expected to show slower growth compared to the prior month.
Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California
Thomas McCullough
EVP of Commercial Bank of California
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