Labor costs revised higher, worrying markets

09/06/2006

NEW YORK (Reuters) - U.S. labor costs have risen more robustly this year than first thought, a government report showed on Wednesday, increasing concerns the Federal Reserve may start raising interest rates again to contain inflation.

U.S. business productivity, a measure of worker output and a key to rising living standards, also grew faster in the second quarter than initially estimated, the Labor Department report said, while a separate survey showed the U.S. service sector grew faster than expected in August.

Later, the Federal Reserve offered a more mixed picture on growth in its Beige Book summary of regional economic conditions. The Fed said the overall economy expanded from mid-July to late August, but five of its 12 districts reported slowing growth as residential construction slackened and energy costs rose.

Still, the labor costs report hit financial markets hardest, weighing on stocks and U.S. government bond prices and boosting the dollar, which generally benefits from the prospect of higher rates. After the Beige Book, the greenback pared its gains a bit, while bonds recovered some of their declines.

“You have a very pronounced acceleration in (unit labor costs) and the people at the Fed who are concerned about entrenched inflation will regard this as a very grave development,” said Pierre Ellis, senior economist at Decision Economics in New York.

The Labor Department’s report contained revisions to first-quarter data showing hourly worker compensation shot up by 13.7 percent, well ahead of the previously reported 6.9 percent gain.

In the second quarter, compensation rose at a more subdued, but still strong, 6.6 percent pace.

With investors eager to see whether the Federal Reserve’s forecast that moderating economic growth will soften price pressures is coming true, the report may cause concerns among those already betting the U.S. central bank’s monetary tightening campaign is over.

The gains in worker compensation helped push unit labor costs—a gauge of inflation and profit pressures—up 5 percent over the past year, the largest increase since a matching rise in the period ended in the third quarter of 2000.

In the first quarter, unit labor costs rose by 9 percent and they rose 4.9 percent in the April-June period, well ahead of the 3.8 percent gain economists had expected.

SIZZLING SERVICES

The services sector, which includes businesses as diverse as hair salons and custodial services, also showed signs of strength in recent weeks. The Institute for Supply Management’s services index rose to 57 in August from 54.8 in July. The median forecast of Wall Street economists was for an increase to 55.

“This is a report that improves near-term economic prospects while suggesting that the Fed may not be finished at reining in inflation risks,” John Lonski, chief economist at Moody’s Investors Service in New York, said of the ISM report.

The Federal Reserve held interest rates steady at its latest meeting on August 8, but some analysts say it may not yet have finished tightening credit.

The Labor Department said U.S. productivity has risen 2.5 percent over the past year, a solid increase in line with the gains seen since the mid-1990s.

While some economists have worried U.S. productivity growth might slow, imparting further upward pressure on inflation, Fed Chairman Ben Bernanke said last week the beneficial trend seen since the mid-1990s looks likely to stay in place.

In the Beige Book, the Fed said there were widespread price increases for energy, metals and other commodities, but these did not appear to be triggering more general consumer inflation.

“When you are looking at the guts of the Beige Book, you see signs of continued moderation in the economy,” said Kevin Flanagan, fixed income strategist for global wealth management with Morgan Stanley in Purchase, New York.

Separately, the Mortgage Bankers Association said applications for U.S. home mortgages edged higher last week as lower loan rates helped encourage more home purchases for the first time since early August.