U.S. business activity contracts in July for first time in 2 years, survey shows

July 22 (Reuters) - U.S. business activity contracted for the first time in nearly two years in July as a sharp slowdown in the service sector outweighed continued modest growth in manufacturing, painting a glum picture for an economy stunted by high inflation, rising interest rates and deteriorating consumer confidence.

S&P Global on Friday said its preliminary - or "flash" - U.S. Composite PMI Output Index had tumbled far more than expected to 47.5 this month from a final reading of 52.3 in June. With a reading below 50 indicating business activity had contracted, it is a development likely to feed into a vocal debate over whether the U.S. economy is back in - or near - a recession after rebounding sharply from the downturn in early 2020 at the start of the COVID-19 pandemic.

July's fall marked the fourth monthly drop in a row and was largely driven by pronounced weakness in the services sector index, which fell to the lowest since May 2020 at 47.0 from 52.7 a month earlier. That was enough to offset relative steadiness in manufacturing, with the group's factory activity index edging down to 52.3 from 52.7, indicating the sector was still growing but now at its weakest pace since July 2020.

Economists polled by Reuters had a median estimate for the services sector index at 52.6, while the manufacturing index was seen coming in at 52.0.

"The preliminary PMI data for July point to a worrying deterioration in the economy," S&P Global Chief Business Economist Chris Williamson said in a statement. "Excluding pandemic lockdown months, output is falling at a rate not seen since 2009 amid the global financial crisis."

S&P Global's measures of new orders in the manufacturing sector, outstanding business in the services sector and future expectations in both fell to levels not seen since the first year of the pandemic.

The report was the latest in a spate of economic indicators that have "surprised" to the downside relative to economists' expectations and have fueled anxiety from Wall Street to Main Street over whether the economy is stalling out. Citigroup's U.S. Economic Surprise Index last month registered its lowest reading since May 2020 and has remained negative so far in July.

The S&P Global data point to U.S. gross domestic product falling at roughly a 1% annualized rate, Williamson said. The economy contracted at a 1.6% rate in the first quarter, largely because of business inventory management issues, and the government next week will provide its first reading of output in the second quarter, which some models suggest will show a second straight contraction.

The report also painted a picture of a softening employment scene, which so far has defied expectations for a notable slowdown, with unemployment still near a half-century low. S&P Global said its manufacturing employment index dropped to the lowest since July 2020 while services employment registered its weakest growth since February.

On Thursday, the Labor Department reported that new claims for jobless benefits rose to the highest since November last week and that, as of a week earlier, the total number of people drawing unemployment assistance had risen to the highest since April. That said, both remain below historic norms.

(Reporting by Dan Burns; Editing by Andrea Ricci)