WASHINGTON (Reuters) - U.S. services sector activity slowed in July as new orders dropped to their lowest level in three years, suggesting the economy lost further momentum early in the third quarter.

FILE PHOTO: Shoppers ride escalators at the Beverly Center mall in Los Angeles, California November 8, 2013. REUTERS/David McNew/File Photo

The report from the Institute for Supply Management (ISM) added to last week’s data showing a slowdown in hiring and prolonged weakness in manufacturing in July.

These reports, together with an escalation in the trade war between the United States and China, suggest the Federal Reserve will cut interest rates gain next month to sustain the 10-year economic expansion, the longest in history. The U.S. central bank last week cut its short-term rate citing rising risks to the economy from trade tensions and weakening global growth.

“The trade war was already inflicting damage to the economy, and now it has been ramped up,” said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto. “The Fed will step in again, likely in October but possibly sooner, but there is only so much already-low rates can do.”

The ISM said its non-manufacturing activity index fell 1.4 percentage points to a reading of 53.7. It was the second straight monthly decline in the index. A reading above 50 indicates expansion in the sector, which accounts for more than two-thirds of U.S. economic activity.

Economists polled by Reuters had forecast the services index would slip to a reading of 55.5 in July. The ISM reported last week that factory activity slowed to a three-year low in July, noting that “trade remains a significant issue.”

President Donald Trump on Thursday announced an additional 10% tariff on $300 billion worth of Chinese imports starting Sept. 1. China let the yuan breach the key 7-per-dollar level on Monday for the first time in more than a decade.

The deterioration in the trade relations between the two economic giants pressured financial markets. The dollar .DXY dropped against a basket of currencies. Stocks on Wall Street tumbled.

Treasury prices rose, with the gap between the three-month Treasury bill rate and 10-year yields jumping nearly 27 basis points, the widest since April 2007. This curve “inversion” between the two maturities has preceded every U.S. recession in the past 50 years.

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SLOWING ECONOMY

Economists said last month’s slowdown in the services industry measure was consistent with slowing economic growth.

“Although today’s reading is consistent with the deceleration that we have been anticipating for some time with the waning of fiscal stimulus and tighter financial conditions, the weaker-than-expected reading hints that tepid growth in the trade-exposed goods sector may be spilling into domestic demand,” said Jonathan Millar, an economist at Barclays.

The economy grew at a 2.1% annualized rate in the second quarter, down from a 3.1% pace in the January-March quarter. Growth estimates for the third quarter are around a 1.5% rate. The economy is slowing largely as the stimulus from last year’s $1.5 trillion tax cut fades.

The ISM described the pace of growth in the services sector as continuing “to cool off, noting “ongoing concerns related to tariffs and employment resources.”

The ISM’s services sector measure of new orders fell to a reading of 54.1 last month, its lowest since August 2016, from 55.8 in June. A gauge of new export orders dropped to 53.5 in July from a reading of 55.5 in June.

There was also a further deceleration in prices paid for materials and services, pointing to benign inflation. But a measure of services industry employment increased to a reading of 56.2 in July from 55.0 June. This suggests job growth will likely remain solid, even though the pace of hiring is slowing.

The economy created 164,000 jobs in July, pulling back from the 193,000 positions added in June, the government reported on Friday.

According to the ISM, 13 non-manufacturing industries reported growth in July, including accommodation and food services, utilities and professional. The five industries reporting a decline included retail trade, wholesale trade and educational services.

The construction industry said “tariffs continue to push costs higher, and customers are looking for more discounts due to mortgage rate fluctuations. Respondents in the public administration sector described demand as “strong” but also complained about “pressures for skilled labor.”

While a separate survey from data firm Markit offered an upbeat assessment of the nonmanufacturing industry in July, service providers were less optimistic about the future.

“With trade tensions escalating over the past few days since the end of July, we think further weakening in business sentiment is likely, although upcoming policy actions remain uncertain,” said Daniel Silver, an economist at JPMorgan in New York.