Productivity Rise Eases Fed Pressure

U.S. productivity remained elevated in the 2nd-Q despite a sluggish economy and weak manufacturing, making it easier for Fed Reserve officials to balance risks to both economic growth and inflation while holding interest rates low. Labor costs, meanwhile, slowed markedly, suggesting high energy prices have not triggered the kind of wage-price spiral that bedeviled policymakers in the 1970s and early 1980s. Meanwhile, inventories held by U.S. wholesalers continued to rise in June, growing nearly twice as much as expected although climbing at a slower clip than sales, a government report released recently said. Nonfarm business productivity increased 2.2%, at an annual rate, in the 2nd-Q, the Labor Dept. said. The 1st-Q gain was unrevised at a 2.6% gain. Compared to the 2nd-Q of 2007, productivity rose 2.8%. Productivity is defined as output per unit of labor. Unit labor costs, a key gauge of inflationary pressures, advanced 1.3%, below Wall Street forecasts for a 1.6% increase. Labor costs were up a modest 1.5% from one year ago, an indication the economic slowdown and slackening jobs market is making it harder for workers to command higher wages. Labor is the biggest input in the production of goods and services. If not matched by productivity, higher wage, energy and material costs are either passed along by a company in the form of higher prices or absorbed in profit margins. Productivity so far this year has bucked its usual pro-cyclical nature, up in good times and down in slumps, by remaining sturdy even as the economy skirts near recession. That in turn gives Fed officials the flexibility to pursue an easier monetary stance than would otherwise be the case, since high energy and other material costs need not translate into broad-based gains in consumer prices. In a recent policy statement, officials said inflation remains a "significant" worry. Still, many economists expect the Fed to hold the target federal funds rate for interbank loans at just 2% for the rest of the year, a forecast supported by the recent productivity and labor cost data. In congressional testimony last month, Fed Chairman Bernanke called it "very striking that even during all this uproar U.S. labor productivity has continued to grow faster than almost any other industrial country, and it just shows how strong this economy is." But there's a flip side in the short term to fast productivity: labor markets are likely to stay under pressure as companies squeeze additional output from each worker. The U.S. shed jobs during the first 7 months of the year, a sign companies reacted quickly to the economic slowdown by cutting on labor. Manufacturing sector productivity surprisingly fell 1.4% in the 2nd-Q, according to Friday's report, with losses concentrated in durable-goods manufacturing, usually one of the more productive sectors of the economy. The drop in manufacturing productivity was the 1st in over 2 years and the durable-goods drop was the largest since 1970. The Labor Dept. said manufacturing data "tend to vary more from quarter to quarter than data for the aggregate business and nonfarm business sectors." Nonfarm business output increased 1.7% during the second quarter, the Labor Dept. said. Hours worked fell 0.5%. Hourly compensation increased 3.6%. Real compensation, adjusted for inflation, fell 1.4%, a sign worker paychecks aren't keeping pace with inflation. That can hurt consumer spending in coming months. The recent data included productivity revisions for the last 3 years. The data showed downward revisions to productivity growth in 2005 and 2007, including a 1%-point drop in the estimate for 4th-Q productivity growth, to 0.8%. GDP data released last week showed GDP actually fell slightly in the 4th-Q. Prior estimates had shown a slight rise.