The services sector continued its expansion in September but at a considerably slower pace than expected, according to the ISM Non-Manufacturing Index released Thursday.

The closely watched measure came in at 52.6, compared with an expected reading of 55.3 from economists surveyed by Dow Jones. It was the weakest reading since August 2016.

Markets initially sold off sharply following the news, with the Dow Jones Industrial Average down as much as 300 points before erasing losses.

ISM officials said the overall weakness arose from fears over tariffs, labor resources and the general direction of the economy. The news comes just two days after the ISM's companion manufacturing index also showed substantial weakness.

"Net, net, look out below is what purchasing managers from services industries are shouting at the markets as the fears of recession continue to mount," Chris Rupkey, chief financial economist at MUFG, said in a note. "Stock investors don't like that the doom and gloom in the manufacturing sector is starting to infect the bigger part of the economy that employs millions of workers in services industries including health care, retailing, business administration, accounting, computer services on and on."

The survey gauges the percentage of companies expecting to expand their businesses. Anything above 50 represents growth; a reading above 48.6 has been consistent with broader economic growth.

The report comes amid worries that the U.S. economy faces a recession as global growth slows and tariffs put a dent in business plans to expand. For example, CNBC's All-America Economic Survey on Thursday found that just 23% of Americans believe the economy will improve in the next year, the lowest level of optimism in three years.

Market anticipation for Fed interest rate cuts also reacted sharply to the report and were fully pricing in another quarter-point move lower at the Federal Open Market Committee meeting Oct. 29-30.