Job report spurs optimism

The U.S. service sector showed surprising strength last month and the number of Americans lining up for jobless aid fell last week, according to reports Thursday that eased concerns housing market tumult would upend the economy.

The reports offered a fresh take on the economy’s health and, on balance, financial markets saw the data as lessening the need for the Federal Reserve to aggressively cut interest rates to prop up the economy.

“It doesn’t really seem to me that things are as bad as people are making them to be. There might not necessarily be a good case for a rate cut,” said Cleveland Rueckert, market analyst at Birinyi Associates Inc. in Stamford, Conn.

A number of Fed officials Thursday said recent financial market turmoil stemming from rising defaults in the sub-prime mortgage market had raised the risk of an economic downturn.

But they also cautioned that the central bank, which meets Sept. 18 to consider interest rates, had to be careful not to bail out market participants who had made bad investment decisions, unless the economy itself needed a boost.

“Historically, central banks have been the source of the disturbance rather than the solution,” said William Poole, the St. Louis Federal Reserve Bank president.

“We have to make sure that we don’t overreact.”

The Institute for Supply Management said growth in the U.S. service sector, which represents about 80% of overall economic activity, held steady in August.

Although the institute’s non-manufacturing index remained at 55.8 -- well above the 50 level that separates expansion from contraction -- its employment index slumped to 47.9 from 51.7 in July.

It was the first contractionary reading on services employment since July 2004 and the lowest jobs index level in nearly five years.

A report on initial claims for state unemployment benefits from the U.S. Labor Department, however, suggested that the job market remained fairly solid.

The department said the number of new applications last week for state unemployment benefits dropped 19,000 to 318,000 last week. Analysts were expecting a decline of about a third of that amount.

A separate Labor Department report showed U.S. worker productivity was stronger in the second quarter than estimated, while growth in labor costs was slower. This was welcome news for the Fed, which has spent much of the year worrying about inflation.

“We got a trifecta of good economic reports today,” said Richard Huber, economist at A.G. Edwards & Sons Inc. in St. Louis.