Stalling US productivity growth likely to trouble Fed

Stalling US productivity growth likely to trouble Fed
By Eoin Callan and Krishna Guha in Washington
Copyright The Financial Times Limited 2006
Published: November 2 2006 20:03 | Last updated: November 2 2006 20:03

US productivity growth stalled in the third quarter, while unit labour costs continued to rise at a strong clip, heightening the dilemma for the Federal Reserve as it seeks to balance the risks from a slowdown in growth and stubbornly high inflation.

The slowdown in productivity, which was flat over the quarter and up only 1.3 per cent over the previous year, was largely the consequence of slowing growth.

But it could also signal that the underlying rate of productivity growth in the US is declining. Unit labour costs rose at an annualised rate of 3.8 per cent, considerably faster than the core rate of inflation as measured by the personal consumption expenditure deflator. But while the increase in unit labour costs is a potential source of concern on inflation, the rate of growth has slowed since the first half of this year.

The latest data on productivity and costs underscores why the Fed is unlikely to cut rates imminently, in spite of continued economic fragility. Further evidence of this came this week with a fall in the ISM manufacturing index, a gauge of manufacturing activity. The ISM index declined for the third consecutive month to 51.2 points. Most regional manufacturing surveys have also come in weak.

Figures released last week showed US third-quarter gross domestic product growth fell to 1.6 per cent. Most analysts expect growth will rebound in the current fourth quarter, as lower oil prices depress imports, though it will probably remain below trend. Some analysts fear an inventory correction could hold back any rebound. There was a further suggestion of the fragility of the economy yesterday as initial jobless claims increased by 18,000 to 327,000 last week, above a consensus forecast of 310,000.

Gary Bigg, an economist at Bank of America Securities, said the rise in new jobless claims was a sign of weakness in demand.

However, Jan Hatzius, an economist at Goldman Sachs, said that the new claims were offset by the drop in continuing claims, which fell 27,000 to 2.4m last week, suggesting “decent hiring continues”.

Mr Hatzius said the data likely to be of more concern to the Fed were those showing that “labour costs continue to grow at a fairly high rate”.

However, while unit labour costs have been rising over the last two years, partly due to slipping productivity, profit margins remain high by historic standards.