Tue Aug 10, 2004
By Tim Ahmann

WASHINGTON (Reuters) - The productivity of U.S. businesses rose at a swifter-than-expected pace in the second quarter but labor costs still gained at their fastest rate in two years, a sign of building corporate cost pressures.

Nonfarm business productivity rose at a 2.9 percent annual rate in the second quarter, the Labor Department said on Tuesday, well ahead of the 2 percent expected by Wall Street but a slowdown from the first quarter's 3.7 percent advance.

It was the smallest productivity gain since the fourth quarter of 2002, but strong enough to convince economists it would still help provide a brake to inflation.

Growing output by workers tamps down price pressures by allowing companies to produce more without higher wage bills.

The productivity slowdown contributed to a rise in the cost of labor per unit of production, which may get noticed by Federal Reserve officials meeting on Tuesday to mull interest rates.

Unit labor costs gained at a 1.9 percent clip as hourly compensation, which includes wages and benefits, rose at a sharp 4.9 percent rate.

"These numbers will probably be of concern to Fed policy-makers if the trend continues," said Gary Thayer, chief economist at A.G. Edwards & Sons in St. Louis.

Because labor represents the biggest production expense for businesses, the rise in unit labor costs suggests worker compensation could begin eroding profits unless firms can raise their selling prices.

The rise in unit labor costs was just below the 2 percent increase forecast by private economists.

U.S. stock markets welcomed the report, with the blue chip Dow Jones industrial average up nearly 78 points near midday. U.S. bonds and the dollar shrugged off the data as traders kept their focus on the Fed meeting. An announcement by the central bank is expected at around 2:15 p.m.

PRESSURES BUILDING

The sting from the latest rise in unit labor costs was tempered by a downward revision to the measure for the first quarter, which was lowered to a 0.3 percent advance from the previously reported 0.8 percent gain.
Over the past year, unit labor costs have barely budged, edging up just 0.2 percent.

Economists said the productivity report showed businesses continued to find new efficiencies that allowed them to boost output while holding the line on hiring.

Rising productivity raises standards of living in the long run as it lets businesses keep prices down. In the short run, however, it can prove a hurdle to job creation if demand is not strong enough.

Most analysts expect Fed officials to raise overnight borrowing costs by a quarter-percentage point to 1.5 percent on Tuesday despite a weak jobs report on Friday, though some think the central bank may hold its fire.

Traders will be especially interested in how the Fed characterizes an economic slowdown in June.

Two reports released on Tuesday on U.S. chain store sales showed shopper traffic slowed last week.

The International Council of Shopping Centers and UBS said in a joint report that sales grew 0.1 percent in the week ended Aug. 7, slightly off from a 0.2 percent rise in the previous week. Sales were up 3.1 percent from year-ago levels.

A separate report from Redbook Research showed sales up 2.4 percent from a year ago, but off 0.5 percent so far this month when compared with July.

ON TRACK?

Most economists still think the economy is on track for a solid expansion this year, although the latest consensus forecast from the Blue Chip Economic Indicators newsletter released on Tuesday showed forecasters trimming projections.

The Blue Chip's survey of more than 50 professional forecasters anticipated economic growth of 4.4 percent this year, down from 4.5 percent forecast a month ago. The projection came before Friday's disappointing news on jobs, which may lead some analysts to further cut their projections.

The U.S. economy grew at a 3 percent annual rate in the second quarter after a speedy 4.5 percent gain in the first three months of the year as consumers suddenly turned thrifty.

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