Updated from 9:08 a.m ET
U.S. workers were more efficient than economists expected in the third quarter, the government reported Thursday, but a key inflation indicator rose at its quickest pace since the first half of 1999.
Although it raised the possibility of price inflation, the data -- coupled with a separate report suggesting the economy will remain in slowdown mode in the near future -- did not alarm economists and the financial markets, as Friday's closely-watched employment report looms.
grew at an annual rate of 3.8% in the third quarter, compared with a revised 6.1% rise in the second quarter, the
said. Originally, the government reported that productivity rose 5.7% in the second quarter. Productivity grew at a rate of 1.9% in the first quarter. The consensus among economists polled by
was for productivity in the July to September quarter to come in at a 3.1% annual rate.
Manufacturing productivity saw robust growth, rising to a 6.4% annual rate, compared with a 5.7% rise in the second quarter. Durable goods productivity posted the strongest gains in the report, rising 9.6%.
"I was impressed with the productivity figures," said Michael Moran, chief economist at
Daiwa Securities America
, noting the figure was solid in a quarter when the growth in gross domestic product -- a broad measure of the economy's output -- rose 2.7% in the third quarter, lower than expectations and down from a 5.6% rise in the second quarter.
Labor Costs on the Rise
At the same time
unit labor costs
, a broad measure of how much businesses pay per unit of output and a key inflation indicator, was also up higher than expectations. Unit labor costs rose 2.5%, the highest rate of increase since the second quarter of 1999, compared with the
estimate of 1.5%. Unit labor costs fell 0.4% in the second quarter.
"This is a development that is going to lead Fed officials to be nervous about inflation reports," Moran said.
While the rising labor costs do raise the specter of inflation, it is also consistent with the
so-called "soft landing," its term for efforts to engineer a cooling of the economy through a series of interest rate hikes begun 17 months ago. Amid numerous signs of a slowing economy, the Fed left rates unchanged at its August and October meetings.
Most economists agree that productivity gains cannot keep the same pace of the last year or so, which means that a rise in unit labor costs is inevitable since the two -- productivity and labor costs -- move in opposite directions.
"I don't think the 2.5% increase should be viewed as particularly disconcerting," said Anthony Karydakis, senior financial economist at
BancOne Capital Markets
Rates Likely to Stay Steady
America's long-running economic expansion has been fueled by steep gains in productivity, which has created the new economy mantra that an increase in productivity has severed the traditional relationship between inflation and unemployment. This relationship posits that low unemployment will eventually lead to inflation because workers will demand wage increases.
Historically, economists considers 2% to 2.25% annual growth in productivity to be the most the economy could handle. Now, a realistic goal is 3.5% to 4% on a steady basis, said Karydakis, lower than the 8% rate in last year's fourth quarter but considerably higher than what was historically considered a solid growth rate.
"Clearly, the behavior of productivity will be one of the key elements that influence the thinking of the Fed over the next six months," Karydakis said.
While the plethora of economic news suggesting a slowdown has raised the possibility of a Federal Reserve cut in interest rates in the near-term, the more likely scenario is for the Fed to leave rates alone at its next meeting Nov. 15 as it monitors the economic soft landing, said economists.
The market will be closely watching Friday's employment data, which will give further indications of where the Fed is leaning. A report that suggests lower unemployment could unnerve the markets, since it would be considered inflationary, especially following Thursday's rise in unit labor costs.
The markets will also eagerly await the Fed's Nov. 15 meeting. Although most expect interest rates to remain as they are, the Fed's statement that it releases following each meeting will be dissected for signs of where policymakers see the economy heading.
"One of the big issues is how the Fed will characterize the economy and risks in its next policy statement," said Moran, the Daiwa economist. At its last meeting, the Fed said it saw hints of inflation in the economy, giving an indication it had no plans to cut rates.
Leading Indicators Unchanged
Separately, the index of leading indicators remained unchanged in September, reported the
, a private research group. The index, a gauge of the future health of the U.S. economy, has fallen in recent months in step with the slowing economy.
The index, which rarely influences markets since it is a composite of previously released data, has not registered a gain since January.
"The leading index gives little reason to be optimistic," said Dan Green, an analyst at
. "But it is important not to overstate the importance of the index's declining trend. The index is more likely pointing to a soft landing rather than a recession."