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Productivity revised higher to 0.2% in third quarter
Unit-labor costs show less inflationary pressure building:

By Rex Nutting, MarketWatch
Last Update: 9:07 AM ET Dec 5, 2006

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WASHINGTON (MarketWatch) -- Inflationary pressures stemming from higher wages are not building as fast as previously thought, Labor Department data released Tuesday show.

Unit-labor costs -- a key measure of inflationary pressures stemming from a tight labor market -- were revised much lower in both the second and third quarters, said the government. Instead of rising at a 5.3% pace in the past year, unit-labor costs in the nonfarm business sector were revised to a much-tamer 2.9% annual pace.

The Federal Reserve's chief worry about inflation was largely revised away. The Fed had been expressing concern that wage pressures were building, and that they'd inevitably feed into higher prices. The revised data show no trend toward higher wages.

The Fed is expected to keep its overnight interest-rate target at 5.25% at its meeting next week. Investors and analysts are looking for the Fed to cut rates in March or May, but Fed officials have expressed very little concern that economic growth is fading too much. They continue to maintain a party line that inflation -- not weak growth -- is the Fed's biggest worry.

Productivity in the nonfarm business sector rose at a 0.2% annual pace in the third quarter, revised from no gain previously reported. Economists had expected productivity to be revised to 0.4%

Unit-labor costs, meanwhile, were revised to a 2.3% annualized from 3.8% previously.

The revision to unit-labor costs in the second quarter was much more dramatic. Instead of a 5.4% increase, unit labor costs fell 2.4%. The revision was largely due to a downward revision in wages and salaries in the second quarter, as reported in last week's report on gross domestic product.

In the second quarter, real hourly compensation (that is, inflation-adjusted) fell at a 5.9% annual pace, rather than the 1.6% increase reported a month ago. In the third quarter, real hourly compensation fell 0.4%, revised from a 0.7% gain.

In the past year, productivity has risen at a 1.4% annual pace, still the slowest gain in nine years. Unit-labor costs have risen at a 2.9% annual pace, down from 3.1% in the four quarters ending in the second quarter. Real hourly compensation has risen 1% in the past year, down from 1.6% in the second quarter.

The report was even better in the nonfinancial sector, which some Fed officials say is a much better gauge of productivity and unit labor costs. In the nonfinancial sector, productivity rose 5.6% in the third quarter and is up 3.8% in the past year. Unit labor costs fell 2.7% in the third quarter and are up 0.5% in the past year. Real hourly compensation fell 0.1% in the third quarter and is up 0.9% in the past year.

Productivity, a concept that's simple in theory but elusive in practice, is output divided by hours worked. Productivity gains are the key to higher living standards, higher wages, increased profits and low inflation.

The economy had undergone a productivity boom in the past five years. After averaging about 2% in the post-war years, productivity gains have averaged 3.1% from 2000 to 2005. Unit labor costs had increased an average of 0.8% since 2000 through 2005.