updated 6/5/2007 1:10:09 PM ET 2007-06-05T17:10:09

Surprising strength in the nation’s service economy, coupled with recent data showing the manufacturing sector is humming along, suggest the broader economy may be shaking off slumps in the housing and automotive industries.

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The Institute for Supply Management, based in Tempe, Ariz., said Tuesday its index of business activity in the non-manufacturing sector registered a faster-than-expected pace of 59.7 in May. The reading was higher than April’s reading of 56 and Wall Street’s expectation of 56.

A reading above 50 indicates expansion, while one below indicates contraction.

The new orders index was 57.4, up from 55.5 in April. The employment index rose to 54.9 from 51.9.

“The core indexes — new orders and employment — are up moderately, and that signals the economy is improving,” said Brian Bethune, an economist with Global Insight.

An overly pessimistic outlook led to the “first-quarter malaise,” Bethune said, and now companies are realigning their orders, employment and inventory to match a more robust growth.

The service industries covered by the ISM report represent about 80 percent of economic activity and span diverse industries including banking, construction, retailing, mining, agriculture and travel.

May represents the 50th consecutive month of growth in the non-manufacturing sector, and marked a turnaround from March when the index slipped to a four-year low. The index average so far this year is still below the 2006 average reading of 58.

The manufacturing sector also showed strength in May, with the ISM reporting last week that the sector rose to its highest level in a year. The reading of 55 marked the fourth consecutive month of growth.

The ISM reports may explain Fed Chairman Ben Bernanke’s forecast Tuesday morning that the economy will recover from its recent feeble performance. The gross domestic product rose a barely discernible 0.6 percent in the first three months of the year, dragged down by ongoing sluggishness in the housing and automotive industries. The GDP is a measure of the economy’s total output.

Bernanke said the economy would rebound despite a housing slump that “appears likely to remain a drag on economic growth for somewhat longer than previously expected.”

The country’s top corporate executives also foresee good business prospects in coming months. The Business Roundtable said Tuesday most executives expect sales, capital investment and hiring to remain at current levels or be boosted in the coming months.

The strength of the global economy may account for the surprising uptick in the service economy, said Mark Zandi, chief economist at Moody’s Economy.com.

“That’s a big part of the story. The global economy is performing about as well as it ever has. Combined with a weaker dollar, it’s lifting orders from U.S. businesses,” Zandi said.

The ISM index for new export orders rose to 66, up from 55.5 in April.

While the strong ISM reading reflects the pickup in the economy, it doesn’t signal that the broader economy is due for a significant upswing in coming months, Bethune said.

“One number does not make a trend. There’s nothing to suggest this is going to continue to accelerate,” he said.

The pace of growth will likely fall back to a more moderate level in coming months, he said.

Analysts said the ISM report nevertheless indicated a healthy service sector, with the new orders and employment indexes both growing at a faster pace in May.

The 12 industries reporting growth in May, listed in order of growth, were mining; arts, entertainment and recreation; information; management of companies and support services; professional, scientific and technical services; utilities; finance and insurance; health care and social assistance; public administration; other services; retail trade; and construction.

The two industries reporting decreased activity were accommodation and food services and wholesale trade.

While a rebounding economy is welcome news, investors worry that unchecked growth could prompt the Fed to hike interest rates, a move that could dampen spending.

Stocks dipped Tuesday after Bernanke’s comments made it appear unlikely the central bank will lower rates anytime soon, however, a disappointment for some investors.

In late morning trading, the Dow fell 51.20, or 0.37 percent, to 13,625.12.

Broader stock indicators also declined. The S&P 500 index lost 4.98, or 0.32 percent, to 1,534.20, and the Nasdaq composite index decreased 7.82, or 0.30 percent, to 2,610.47.

Bonds slipped after Bernanke’s comments, and fell further after the strong service sector data. The yield on the benchmark 10-year Treasury note rose to 4.97 percent from 4.93 percent late Monday. The 10-year yield has been trading at 9-month highs, and appears poised to break through 5 percent, a level not reached since August 2006.

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