The pace of earnings growth may be gradually slowing, but the journey back to normal is taking longer than policy makers at the Federal Reserve might like to see, according to one of the most comprehensive measures of wage inflation.
Compensation costs for civilian workers climbed 1.1% in the third quarter, the Labor Department reported Tuesday, marking a mild acceleration from the previous three-month period and coming in a touch faster than consensus forecasts. Economists surveyed by FactSet had expected total compensation costs to have climbed 1% in the three months ending in September, matching the pace set in the three months ending in June.
The deceleration in wage growth is more evident on an annual basis, according to Tuesday’s data, which came as part of the quarterly Employment Cost Index release. Compensation costs were up 4.3% year over year in September, compared with the 5.2% year-over-year pace set in September 2022. Though that’s substantial progress, most economists say wage growth will need to slow to a roughly 3.5% annual pace to bring inflation in line with the central bank’s 2% annual growth rate target.
The data amounted to what Gregory Daco, chief economist with EY-Parthenon, labeled a “disappointingly gradual moderation in labor cost pressures despite broad-based evidence of labor market rebalancing.”
“Wage growth remains above the Fed’s comfort zone,” he added.
The latest figures are unlikely to move the needle for an interest-rate increase at the Fed’s current policy meeting, which began Tuesday and will run through Wednesday afternoon. Fed policy makers are all but certain to hold interest rates steady at the current level of 5.25% to 5.5%. And though officials have penciled in one more rate hike this year, most investors expect the central bank to hold rates steady in the December meeting as well.
What the ECI data will do is reinforce the expectation that the Fed may need to keep rates higher for longer—or, in other words, hold them in restrictive territory for an extended period before considering rate cuts—because of the amount of time it could take for inflation to slow. And it will keep the possibility of that December rate increase squarely on the table—in part because the Fed is concerned rapid wage growth could contribute to the risk of inflation reaccelerating next year, noted Bill Adams, chief economist with Comerica Bank.
The central bank has been closely focused on worker pay growth in recent months because wage inflation drives the cost of services higher. Price growth in core non-housing services remains elevated, so far proving resistant to the Fed’s efforts to slow the economy.
The bright spot, however, is that while the cool-down might be slow, wage growth is at least moving in the right direction. Pay growth among public-sector employees, which climbed 1.5% in the third quarter, fueled the upside surprise in compensation for the quarter. Private-sector compensation rose a milder 1%.
Given how public-sector workers tend to see raises after their private-sector counterparts, as Wells Fargo economists noted, the quarter-over-quarter increases could still be on track to slow further in the months to come.
“Any policy easing remains distant in our view,” the Wells Fargo team led by Sarah House wrote. “That said, the moderating trend in labor cost growth alongside signs of a further slowdown to come over the next few quarters suggests little need for the Fed to tighten policy further from here, and we continue to believe that the current hiking cycle has come to an end.”
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