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By Daniel Bases
Mon Apr 5, 2004

NEW YORK (Reuters) - A key measure of the vast U.S. services sector grew with surprising strength to hit a record high in March, offering further evidence that economic recovery is gaining traction, a report showed on Monday.

The Institute for Supply Management's non-manufacturing index surged to 65.8 in March, a 12th straight monthly increase, from 60.8 in February. Wall Street economists had forecast a rise to 61.5. A number above 50 indicates growth.

"This is a pretty strong report and consistent with the better jobs number we saw on Friday. This shows the recovery is continuing to build momentum," said Mark Vitner, economist at Wachovia Securities in Charlotte, North Carolina.

The report showed growth in both employment and prices paid for raw materials. Services account for about 80 percent of the U.S. economy and include everything from restaurants and hotels to banks and airlines.

The survey's employment index rose for a sixth consecutive month in March, to 53.9 from 52.7 in February.

Employment is a hot-button election year issue. The record high reading and strength in the employment index last month were tempered by some very cautious statements from survey respondents.

Respondents were not uniformly positive, despite the rise in the indexes. Some said they were hiring and converting temporary jobs to permanent positions, but others said they are still cutting jobs or maintaining hiring freezes.

Growth in new orders rose to 62.8 in March from 60.3 in February, while the prices paid component rose for the 24th straight month, to 65.7 from 57.3.

The ISM's non-manufacturing report said there were significant shortages of some commodities, especially steel items, while price increases were noted across a broad spectrum including commodities, metals, energy, lumber, telecommunications equipment and services.

"The economy is heating up pretty nicely. The inflation measures are already starting to pick up, though nothing alarming. At some point the Fed has to decide how strong do we want this economy," said Ram Bhagavatula, chief economist at Royal Bank of Scotland Financial Markets in New York.

The strength in services was consistent with gains recorded in the ISM's manufacturing index reported on Friday, especially a willingness expressed by factory owners to add workers.

The industries reporting the highest rate of overall growth were wholesale trade, mining, communication, retail trade, business services and construction.

On Friday, the U.S. Labor Department reported 308,000 new non-farm jobs were added to payrolls in March, well above forecasts, fueling expectations that the Federal Reserve may be inclined to increase benchmark U.S. interest rate from a 1958 low of 1 percent sooner rather than later.

In the wake of Monday's better than expected report, the already strong dollar gained further ground, while benchmark 10-year U.S. Treasury yields (US10YT=RR: Quote, Profile, Research) rose to a three month high of 4.23 percent before drifting slightly lower.

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