For the twelfth-straight month the service sector expanded in December, according to the Institute for Supply Management. Its Non-Manufacturing Index was up a healthy 2.1% last month. That's the biggest increase in its index since last March. Will the sector continue to expand quickly?

Here's the data from ISM, which I have color coded to see the qualitative changes more clearly:

ism services 2010-12.png

With the exception of supplier deliveries, a score above 50 indicates growth. From this chart, it's pretty easy to see that expanding business activity and demand drove the increase in the overall index. The latter is shown by new orders growing more quickly and new export orders also continuing to grow, though at a slower pace than in November.

The bad news, however, is that hiring grew at a slower pace than it had in November. And the other indicators cast doubt on whether hiring will get much more aggressive. For example, while customer demand was increasing (new orders) the current labor force appears to be enough to satisfy it, as the backlog of orders began contracting again during the month.

This month's report also suggests that business-to-business demand might be declining. Inventories are too high and growing more quickly than they can be used up based on customer demand. Supplier deliveries also continue to slow. The manufacturing industry will be adversely affected if service companies cut their purchases of supplies.

Finally, the big increase in prices could hurt the service sector. When input costs rise, there's usually a lag before firms can raise the pricetags customers see on their products and services. As a result, higher costs initially cut into profits. And of course, if profits begin to decline, hiring will be less likely. Moreover, once firms do manage to increase their prices, customer demand could decline as a result, which would also reduce hiring. 

December was clearly a strong month for service sector sentiment, as the ISM report says that companies they polled were broadly positive about the future. But it's pretty clear that some challenges lie ahead. There's also some doubt that the non-manufacturing sector's hiring will be aggressive in the near-term.