WASHINGTON, April 6 (Reuters) - U.S. services sector growth slowed in March, while prices paid by businesses for inputs increased by the most in more than 13 years, an early indication that the prolonged war with Iran was boosting inflation pressures.

The Institute for Supply Management survey on Monday also showed services employment dropping to the lowest level since the end of 2023, which probably understates the health of the labor market as government data last Friday showed a sharp rebound in job growth.

Businesses also reported strong order growth last month.

The Middle East conflict, now in its second month, dominated commentary in the ISM, with businesses ranging from construction to wholesale trade saying it had added an extra layer of uncertainty. Prior to the war, businesses had been dealing with uncertainty stemming from import tariffs.

The survey reinforced economists' expectations the Federal Reserve would keep interest rates unchanged for some time.

"The service sector is still expanding, but headwinds are picking up," said Priscilla Thiagamoorthy, a senior economist at BMO Capital Markets. "With employment softening and inflation pressures flaring up again, the data suggest slower growth alongside sticky price pressures. This keeps the Fed in a difficult position and reinforces the case for patience."

The ISM said its nonmanufacturing purchasing managers' index slipped to 54.0 last month from 56.1 in February. Economists polled by Reuters had forecast the services PMI easing to 54.9.

A reading above 50 indicates growth in the service sector, which accounts for more than two-thirds of U.S. economic activity. Thirteen service industries reported growth included wholesale trade, transportation and warehousing as well as mining, construction and utilities.

The three reporting contraction were retail trade, agriculture, forestry, fishing and hunting, and public administration. Some businesses in the mining sector said "political uncertainty with Iran conflict has resulted in less international business."

Companies in the real estate, rental and leasing industry said "the war in Iran has added an additional layer of uncertainty on top of an already shaky macroeconomic climate." Some wholesalers said "threats to close the Strait of Hormuz and rising war-risk surcharges are pressuring regional logistics costs, even for air freight."

The U.S.-Israeli war with Iran has boosted global oil prices by more than 50%. The national average retail gasoline price has jumped above $4 a gallon for the first time in nearly four years. Economists expect the inflation hit from the war would show in the March Consumer Price Index report scheduled to be released on Friday.

Producer prices already surged in February in anticipation of the escalation in the conflict, which has led to shipping restrictions impacting goods ranging from energy products to fertilizers through the Strait of Hormuz.

The anticipated inflation fallout from the conflict has greatly diminished the odds of an interest rate cut this year. The U.S. central bank left its benchmark overnight interest rate in the 3.50% to 3.75% range last month.

Stocks on Wall Street were trading higher. The dollar was little changed against a basket of currencies. U.S. Treasury yields were steady.

INDUSTRIES REPORT SEEING HIGHER FUEL PRICING

The ISM survey's measure of prices paid by businesses for inputs soared 7.7 percentage points to 70.7, the highest reading since October 2022. This gauge has remained above 60 for 16 straight months, and the percentage increase was the largest in more than 13 years.

"Companies across many industries reported seeing higher gas and diesel pricing, and inventories of multiple goods increased to withstand supply chain disruptions or short-term oil price impacts," said ISM Services Business Survey Committee Chair Steve Miller. "Such construction products as lumber, copper and steel were noted as up in price."

President Donald Trump's sweeping tariffs, though they were struck down by the U.S. Supreme Court, remain an issue. Trump responded to the ruling by imposing a global tariff for up to 150 days.

Wholesalers complained that "landed costs have increased materially." Businesses in the accommodation and food services industry said while tariff rollbacks had resulted in favorable price adjustments, "the news of new implementation is driving continued uncertainty."

The survey's measure of supplier deliveries increased to 56.2 from 53.9 in February. A reading above 50 percent indicates slower deliveries. That mirrored a lengthening in delivery times at factories.

Some service businesses reported that "back orders from suppliers and manufacturers are creating delays," while others said "a shortage of trucks is slowing down deliveries."

Its measure of new orders increased to a two-year high of 60.6 from 58.6 in February. But export order growth slowed considerably and the increase in unfinished work moderated.

Services sector employment contracted, with the jobs measure dropping to the lowest level since December 2023.

That is at odds with a sharp rebound in job growth in March, which was driven by a 143,000 increase in private service-providing payrolls. The ISM employment gauge has, however, not been a good predictor of private services payrolls in the Labor Department's employment report.

"The drop in employment would be more worrisome had we not already had payrolls for March," said John Ryding, chief economic advisor at Brean Capital. "ISM prices paid is a very useful indicator of trends in inflation and this reading should be disconcerting to the Fed and is consistent with inflation running close to 4%."