Nov. 4 (Bloomberg) -- Service industries in the U.S. expanded more slowly than forecast in October, indicating that consumers spooked by mounting job losses are making a limited contribution to the recovery entering the fourth quarter.

The Institute for Supply Management’s index of non- manufacturing businesses which make up the largest part of the economy fell to 50.6 in October from 50.9 in September, according to the Tempe, Arizona-based group. Another report today showed that companies continued to cut employees.

The reports highlight concerns of Federal Reserve policy makers that labor-market weakness threatens to curb household demand, leaving the economy dependent on government aid to maintain the expansion. Central bankers led by Chairman Ben S. Bernanke today reiterated their intention to keep rates near zero “for an extended period,” even after acknowledging that the economy had picked up.

“You’re not getting the kind of momentum that people expect,” said Steven Ricchiuto, chief economist at Mizuho Securities USA Inc. in New York, who forecast the index would drop to 50.5. “People aren’t hiring and we’re not really seeing a big improvement in demand. We’ll probably be in a softer-growth period this quarter.”

Stocks erased almost all the rally that followed the Fed’s announcement as financial shares retreated. The Standard & Poor’s 500 Index rose 0.1 percent to close at 1046.50 after being up as much as 1.5 percent. Treasury securities fell, pushing the yield on the 10-year note up to 3.52 percent at 4:22 p.m. in New York from 3.47 percent late yesterday.

Health Care, Housing

The ISM index, covering services such as health care, housing, and transportation that account for 90 percent of the economy, was projected to increase to 51.5, according to the median forecast of 77 economists surveyed by Bloomberg News. Fifty is the dividing line between expansion and contraction.

A separate report from ADP Employer Services today signaled unemployment will keep climbing. Companies cut an estimated 203,000 jobs in October. The figures, which don’t include hiring by government agencies, were forecast to show a decline of 198,000 jobs, according to the median estimate of 34 economists in a Bloomberg survey.

“I’m still expecting to see payroll employment decline probably through the end of the year, not turn up until January or February,” Joel Prakken, chairman of Macroeconomic Advisers LLC, which produces the report jointly with ADP, said on a conference call.

Employment Index

Reinforcing concerns about the labor market, the ISM’s index of employment dropped to 41.1, the lowest level since May, from 44.3. The gauge of new orders increased to 55.6, the highest level in two years, from 54.2 the prior month.

A Labor Department report in two days will probably show the jobless rate rose to 9.9 percent in October, a 26-year high, and payrolls fell by 175,000 workers, according to the median forecast of economists surveyed.

“Businesses are still cutting back on fixed investment and staffing, though at a slower pace,” the Federal Open Market Committee said in a statement today after meeting in Washington. The policy makers also said that high unemployment and low levels of capacity use, along with “subdued” inflation and expectations that prices will remain stable, merit keeping borrowing costs down.

Fed Action

Fed policy markers are reluctant to raise rates until the labor market shows signs of recovery, even though figures last week showed the economy expanded at a 3.5 percent annual pace in the third quarter after 12 months of contraction. Economists surveyed by Bloomberg early last month forecast growth will cool to a 2.4 percent rate this quarter.

“It’s going to be a very moderate recovery, high unemployment for a long time, inflation staying under good control, probably core inflation declining further,” former Fed Governor Lyle Gramley, now senior economic adviser with New York-based Soleil Securities Corp., said before today’s reports.

Johnson & Johnson, the world’s largest health-products company, is among companies still cutting jobs. The New Brunswick, New Jersey-based company said Nov. 3 it will shrink its workforce by 6 percent to 7 percent, affecting more than 7,000 workers.

Tax Credits

Growth last quarter was spurred by federal tax credits of up to $8,000 for first-time homebuyers and “cash-for- clunkers” rebates of up to $4,500. The auto rebate program expired in August, and Congress is debating extending the homebuyer credit after it expires at the end of November.

Homebuilding, which is included in ISM’s services index, contributed to economic growth in the third quarter for the first time since 2005. The number of contracts to buy previously owned homes rose in September for an eighth month, signaling sales may keep rising in coming months.

Cash for clunkers “stimulated new vehicle sales and was a psychological signal to consumers that it was safe to begin to buy again,” Michael Jackson, chief executive officer at AutoNation Inc., the biggest U.S. auto retailer, said on a conference call last week.

The need to prevent inventories from falling even more as sales improve is giving U.S. manufacturing a boost. The ISM purchasing managers’ group said two days ago its factory gauge rose in October to the highest level in more than three years.

To contact the reporters on this story: Bob Willis in Washington at bwillis@bloomberg.net; Timothy R. Homan in Washington at thoman1@bloomberg.net

Last Updated: November 4, 2009 16:32 EST