Oct. 4 (Bloomberg) -- Service industries in the U.S. expanded at the slowest pace in more than three years in September as the housing slump deepened.

The Institute for Supply Management's index of non- manufacturing businesses fell to 52.9, the lowest since April 2003, from 57 in August. Readings above 50 indicate expansion in industries including construction, banking and retailing that account for almost 90 percent of gross domestic product.

The report suggests the economy is losing momentum as the fourth quarter begins. A weakening housing market that has left Americans feeling less wealthy is limiting consumer spending at retailers such as Wal-Mart Stores Inc. and dragging on growth, making it likely the Federal Reserve will keep interest rates unchanged.

``It looks increasingly as if growth has downshifted to a slower pace that will hold inflation in check and keep the Fed on the sidelines for the rest of the year,'' said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``The real worry is whether business expectations for the outlook will continue to deteriorate further, and what this will mean for Fed policy next year.''

U.S. Treasuries extended gains after the report, sending yields lower. The yield on the benchmark 10-year note fell about 5 basis points, or 0.05 percentage point, to 4.57 percent at 10:34 a.m.

The index was expected to fall to 56, the median forecast in a Bloomberg News survey of 58 economists. The measure averaged 59.6 in the first half of the year.

In a sign that consumer spending may be slowing, Wal-Mart, the world's largest retailer, today reduced its September U.S. comparable-store sales growth estimate to 1.3 percent, the smallest gain since June.

Factory Orders

A separate government report today on factory orders suggested that production is also easing. Orders were unchanged at $403.6 billion in August after a 1 percent decline in July, the Commerce Department report showed. Excluding the volatile transportation equipment category, orders fell 0.7 percent, the biggest decrease since February.

Service industries are cooling in Europe as well. Royal Bank of Scotland Group Plc's services index fell to 56.7, a 10- month low, from 57.4 in August, the company said today in London.

The ISM's index of new orders for U.S. non-manufacturing industries rose to 57.2 from 52.1 in August. A measure of prices paid fell to 56.7 from 72.4.

An index of employment rose to 53.6 from 51.4, and a gauge of inventories decreased to 50.5 from 51.5.

Economic growth has slowed with the end of the five-year housing boom, making it harder for consumers to borrow against the equity in their homes and making them feel less wealthy.

Economic Forecast

The economy is forecast to grow at an average annual rate of 2.7 percent in the last half of this year, in line with the 2.6 percent pace registered in the second quarter, according to a Bloomberg survey of economists from Sept. 1 to Sept. 7. The economy grew at a 5.6 percent rate in the first quarter.

Home construction fell at an annual rate of 11.1 percent in the second quarter, the biggest decline since the same three months in 1995, the government said last week. The decrease has prompted builders to lower prices to drum up demand.

The weakness has resulted in smaller home equity gains that homeowners had relied on the last several years as a source of cash. Homeowners extracted a net $497 billion at an annual rate from home equity in the second quarter, down from $649.2 billion in the first three months of the year, according to figures from Federal Reserve researcher James Kennedy.

`Major Bubble'

``We've had a major bubble that's bursting before our very eyes and it's going to take a big toll on growth prospects going forward,'' said Stephen Roach, chief global economist at Morgan Stanley in New York.

Atlanta-based Lowe's Cos., the second-largest U.S. home- improvement retailer, on Sept. 26 reduced its forecasts for profit and sales for the third time this year.

``Near-term pressures on the U.S. consumer have led to a more cautious outlook for the second half of the year,'' Lowe's Chief Executive Officer Robert Niblock said in a statement.

Cheaper gasoline prices are bringing some relief to consumers, helping keep the economy from slowing even more. The average price of a gallon of gasoline fell to $2.33 at the end of September, from $2.84 on Aug. 28, according to the American Automobile Association.

``It helps the consumer to see these gasoline prices come down,'' said Maury Harris, chief economist at UBS Securities Inc in New York. ``The energy helps but it's not going to offset what's happening in real estate.''

Shopping Centers

The International Council of Shopping Centers this week boosted its September sales forecast to a 4 percent gain compared with the same month last year from a previous estimate of 3.5 percent. The increase would be the biggest since May.

Federal Reserve policy makers will keep interest rates unchanged for a third straight month when they meet on Oct. 24- 25, according to trading in futures contracts tied to the Federal funds rate. The Fed ended a two-year cycle of rate increases in August, keeping its benchmark rate at 5.25 percent.

Manufacturing is also slowing, according to another report this week from the Institute for Supply Management. The group's manufacturing index for September dropped to the lowest since May 2005 while still pointing to expansion.

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By Bob Willis

To contact the reporter on this story: Bob Willis in Washington bwillis@bloomberg.net

Last Updated: October 4, 2006 10:38 EDT

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