Productivity slows, labor costs moderate

WASHINGTON (Reuters) - Worker productivity grew at a slightly slower-than-expected 1.8 percent annualized pace in the second quarter, government data on Tuesday showed, while labor cost growth moderated in somewhat better news for inflation.

It was the largest rise in productivity since the first quarter of 2006, when it was up by 2.5 percent, the Labor Department said.

Economists polled by Reuters had expected the preliminary reading of U.S. non-farm productivity to rise by 2.0 percent as the economy picked up, compared with revised 0.7 percent increase in the previous three months. This was previously reported as a 1.0 percent gain.

"The report does show that productivity improved in the second quarter, but still is growing only modestly and as a result, labor costs are still growing - probably at the high end of the Fed's comfort zone," said Gary Thayer, chief U.S. economist at A.G. Edwards and Sons in St. Louis.

Unit labor costs, a gauge of inflation and profit pressures under close scrutiny by the Federal Reserve as it meets to decide interest rates, mounted by 2.1 percent in the second quarter. This compared with forecasts for a 1.8 percent gain, but was below the revised 3.0 percent increase in the first quarter, up from a 1.8 percent rise previously reported.

The Fed is expected to keep interest rates unchanged at 5.25 percent when it announces the outcome of its meeting shortly after 2:15 p.m. (1815 GMT).

In the report, manufacturing productivity increased at a 1.6 percent annualized pace in the second quarter, the weakest performance since the first quarter of 2004, when it fell by 1.4 percent.

Policymakers monitor productivity, a measure of how much any given worker can produce in an hour, for clues on whether cyclical swings in the business cycle are pressuring inflation, as well as for signals on longer term structural trends.

Weakening productivity amid tight labor markers can spell wage-driven inflation.

"The Fed will hold rates steady again today. They still are concerned about resource utilization and these labor cost numbers still show potential for rising costs of production," Thayer predicted.

In fact, hourly compensation grew by 3.9 percent in the second quarter from 3.7 percent in the first quarter, revised up from a previously reported 2.8 percent gain.

Underlying productivity performance over a period of years also shapes the economy's long-term growth potential, which policymakers estimate for a sense of how fast the economy can grow without sparking price pressures.