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NEW YORK -- The ISM non-manufacturing index showed that the service sector expanded in January 2012 and that the pace of growth accelerated sharply as indicated by the gauge rising to 56.8 from 53.0 in December 2011.

A reading above 50 indicates that the sector is generally expanding; higher readings indicate a faster pace of growth, said David Onyett-Jeffries, an economist with RBC Economics Research. "This represented the highest level for the index since last February and was well above market expectations for a modest increase in the January measure to 53.2," he explained.

The details of the report mirrored the solid headline. “Business activity” and “new orders” each jumped to a 10-month high in January at 59.5 and 59.4, respectively -- up from 55.9 and 54.6, respectively in the previous month. Perhaps most encouraging, the “employment” component surged by 7.6 points to 57.4, which is its highest level since February 2006 and a stark turnaround from last month’s reading that indicated service-sector employment contracted, said Jeffries.

Rounding out the main components of the report, the “supplier delivery” measure declined to 51.0 from 51.5 in December to indicate that delivery times from suppliers were modestly faster than in the previous month, although still slow because supplier delivery times tend to lengthen when capacity is being constrained, he added.

"January’s ISM manufacturing and non-manufacturing surveys indicate that the US economy picked up speed at the start of the new year as the composite index touched a 10-month high of 56.5. Moreover, the gains within the new orders components of each measure suggest that this upward growth momentum may well be sustained during the coming months," said Jeffries.

The reported surge in service-sector employment corroborates the non-farm payroll report released earlier this morning that showed solid broad-based gains, he explained.

"On the whole, today’s reports are encouraging and provide indications that the recovery of the US economy may finally be picking up its pace," said Jeffries. "However, despite the improvement in labor market conditions, the unemployment rate remains well above the Fed’s ‘target’ range of 5.2 percent to 6.0 percent, thereby making it likely that the current highly accommodative policy stance will remain in place for the foreseeable future."

U.S. payroll employment surges in January

Payroll employment in January 2012 rose a robust 243,000 and clearly outpaced market expectations of a more moderate 144,000 increase, said Paul Ferley, assistant chief economist at RBC.

Also encouraging was cumulative upward revisions of 60,000 for the previous two months resulting in gains in December 2011 of 203,000 and in November of 157,000. Strengthening labor markets going into 2012 were also conveyed by the unemployment rate dropping to 8.3 percent from 8.5 percent in December and 8.7 percent in November, he noted

"Expectations were for some slowing in job gains in large part due to the view that the December gain had been buoyed by the transportation and warehousing component jumping 50,200 in the month," said Ferley. "This strength was largely due to a 42,200 surge in the couriers and messengers component that reflected increased Christmas purchases over the Internet. This has been a growing trend in the past two years where strong December gains were followed by almost equal-sized declines in January that weighed on the overall monthly gain in payroll employment."

The BLS, which compiles the employment report, has estimated new seasonal factors that have essentially eliminated this effect, Ferley explained.

The December gain in the transportation and warehousing component was cut to only 6,700. In January, this component managed to rise modestly by 13,100. This change did not prevent an overall, albeit minimal, upward revision to December payrolls, as it was largely offset by greater strength in professional and business services, he added.

The overall payroll gain continues to be weighed down by declining government employment, which dropped 14,000 in January. Thus private-sector employment gained a stronger 257,000 following solid gains in December and November of 220,000 and 178,000, respectively.

Goods-producing industries saw an 81,000 surge in the month that was helped by manufacturing employment showing another solid monthly increase of 50,000. Service-producing jobs were up 176,000 and were led by a 70,000 increase in the professional and business-services components.

The hours worked component of the report indicated that the overall workweek held steady at 34.5 hours although for manufacturing it jumped to 40.9 hours from 40.6 hours in December. The gain in overall employment was thus the main factor sending the index of aggregate weekly hours up 0.2 percent in the month. The level of this index is already up an annualized 2.6 percent relative to the fourth quarter of 2011.

"Such results provide little indication of any marked slowing in economic growth going into 2012. The index for manufacturing was up an impressive 1.2 percent in the month benefitting from both employment gains and a longer workweek," he added.

The index of average hourly earnings, the principal wage measure in the report, rose 0.2 percent in the month and 1.9 percent during the past year. The annual rate is down from 2.1 percent in December.

"The employment report provided encouraging signs that labor markets and economic activity have strengthened going into 2012," said Ferley. "Despite the improvement, however, the unemployment rate remains historically high and above the Fed’s view of a so called equilibrium rate of 5.2 percent to 6.0 percent. Thus, policy is expected to remain highly accommodative to encourage a further closing of this labor market gap. Our forecast assumes the Fed funds at its current highly accommodative level of 0 percent to 0.25 percent going into 2014."

Canada's labor market disappointed in January 2012

Employment increased by a meager 2,300 in January 2012 thereby marking the second monthly rise and working to offset declines in November and October 2011 of 5,500 and 52,700, respectively, said Dawn Desjardins, assistant chief economist at RBC Economics 

"However, January's increase was much smaller than the 22,000 rise expected by forecasters," she noted.

The unemployment rate inched up to 7.6 percent from 7.5 percent in December 2011 as the labor force increased by 23,700. Statistics Canada, in January, made benchmark revisions to the labor data, resulting in a net increase in employment in 2011 of 190,000, which was slightly less than the 199,000 increase in the preliminary estimate for the year. The unemployment rate's recent low in September 2011 was revised to 7.2 percent from 7.1 percent although the end of year rate was unchanged at 7.5 percent.

The details of the report showed that both public and private-sector jobs were created in January although these gains were almost offset by a slump in self-employment, said Desjardins. 

In January, jobs were created in the goods-producing sector of the economy while the services sector cut 7,000 positions. Gains in manufacturing and primary industries were supplemented by hiring in retail and wholesale trade, education, information, culture, and other services.

These gains, however, were largely offset by declines in construction, finance, insurance and real estate, food and accommodation services, and professional services. In total, there were 9,300 goods-sector positions added. Manufacturers added another 10,100 to their workforce, marking the second consecutive month of gains for a total of 36,100.

It was full-time positions that were cut in January with a loss of 3,600 reported while part-time jobs increased by 5,900. In 2011, employers added 205,000 full-time workers to their payrolls with 15,000 part-time jobs lost. The public sector added 19,600 workers in January while private-sector employment rose by an equal amount. The number of self-employed individuals fell by 37,000 in January, which may explain some of the sharp declines in finance, insurance, and real estate (-23,200) and professional services (-44,800).

Quebec's unemployment rate dipped by 0.3 percentage points to 8.4 percent as 9,500 jobs were created in January, thereby tempering the decline during the past 12 months to 45,000. Saskatchewan's unemployment rate posted a 0.2 percentage points decline to 5.0 percent. Ontario lost 7,500 jobs in January, and the unemployment rate rose 0.4 percentage points to 8.1 percent. 

Average hourly wages for permanent workers in January were up 2.2 percent relative to a year earlier.

"The small increase in employment in January was disappointing and runs contrary to recent years when there were big gains at the start of the year," said Desjardins. "The gyrations in the labor market mirror the slowing in activity evident in the final quarter of 2011 with recent data reports consistent with growth at a 1.5 percent annualized rate and a significant slowing from the third quarter's 3.5 percent gain.

"We expect that the economy will post stronger gains in the first quarter of 2012 as temporary factors that reduced activity in the fourth quarter of last year are reversed.," she added. "Our assumption is that the economy will pick-up pace over the course of the year aided by stimulative monetary policy, stronger US growth, and, in our view, that disruptions from Europe will diminish as the problems are contained within the region. In order to ensure that the economy does not stall, the Bank is likely to maintain a very stimulative policy stance throughout 2012."

SOURCE: RBC Economics Research press release