U.S. productivity bounce-back keeps wage pressures tame

By Lucia Mutikani WASHINGTON (Reuters) - Productivity at U.S. nonfarm businesses rebounded strongly in the second quarter, putting a lid on wage pressures and giving the Federal Reserve room to keep interest rates low for a while. The Labor Department said on Friday productivity increased at a 2.5 percent annual rate after contracting at a revised 4.5 percent pace in the first quarter. The first quarter's drop was the sharpest since the fourth quarter of 1981. The bounce back kept labor-related production costs in check. They had surged at the start of the year as an unusually cold winter depressed output. Unit labor costs, the price of labor for any given unit of production, rose at a 0.6 percent rate, braking sharply from an upwardly revised 11.8 percent pace in the first quarter. "The key message here is that labor costs remain subdued and unlikely to represent a source of rising production costs and or inflationary pressures any time soon," said Anthony Karydakis, chief economic strategist at Miller Tabak in New York. The Fed is keeping a close eye on wage growth as it ponders when to raise benchmark interest rates, which it has kept near zero since December 2008. Investors do not expect a rate increase until around the middle of next year. With productivity stepping up, there is more room for workers to win wage hikes without pressuring inflation or profits. Compared to the second quarter of last year, unit labor costs were up just 1.9 percent, below the central bank's 2 percent inflation target. Even so, pay is accelerating. The report showed compensation per hour increased at a 3.1 percent rate in the second quarter, and was up by the same amount from a year earlier. In comparison, hourly compensation advanced only 1.1 percent last year. COMPENSATION RISING Other gauges, such as the government's measure of personal income and its employment cost index, a broad gauge that is one of Fed Chair Janet Yellen's favorites, have also pointed to some firming of wage pressures. "Today's report doesn't say that labor costs are a problem yet, but it hints at some improvement in pay," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. "Fed members, at least the inflation hawks, will likely look at the report as supporting their view that it is time to change direction." It is unlikely that productivity will continue to advance at the second quarter's pace. Over the past three years, it has never topped 1 percent on an annual basis. "Unless productivity growth shows signs of accelerating in the near future, labor costs could begin to put some pressure on profit margins," said Alan MacEachin, an economist at Navy Federal Credit Union in Vienna, Virginia. The second-quarter rebound reflected a sharp step up in gross domestic product in the second quarter. The government said last week that the economy grew at a 4.0 percent rate after shrinking at a 2.1 percent pace in the first quarter. The second-quarter growth estimate, however, is likely to be trimmed when the figures are revised later this month, with a report on Friday from the Commerce Department showing only a moderate gain in wholesale inventories in May and June. Economists said slow wholesale restocking could lower the second-quarter GDP estimate by as much as three-tenths of a percentage point, although data earlier this week showing a smaller trade gap should help offset that a bit. (Reporting by Lucia Mutikani; Editing by Andrea Ricci and Tim Ahmann)