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Jan 14, 2013

Abrupt rise in hourly earnings in U.S. in December

In past, wage inflation picked up when unemployment at 7 per cent
By Jonathan Spicer
    
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The abrupt rise in hourly earnings follows the lowest level of wage growth in decades, so the U.S. economic recovery has lots of room before inflation alarms go off. And there is little evidence of a broader jump in the kind of inflation that would prompt a tighter Federal Reserve policy.

But as the U.S. economy slowly recovers, history suggests the time is right for employers to pay more for talent.

If the pattern continues, December's wage inflation could prove an early sign of change after four years of pressure on paychecks in the wake of the Great Recession and the U.S. central bank's unprecedented efforts to revive the economy.

A few more months of rising wage inflation would be a victory for federal policymakers striving to repair the labour market. But for investors, it could also signal an earlier-than-expected tightening of monetary policy.

The boost in wage inflation is a good sign, although the rise was limited, Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said when asked about the December data.

"Whether or not this is a sign of rising real wages, or whether it's an incipient sign of perhaps stability and inflation down the road, we'll just have to wait and see," he said on Friday.

For now Federal Reserve policy remains ultra easy, although many economists are hopeful this will be the year the U.S. economy finally regains its stride.

Since the depths of recession in late 2008, the central bank has kept interest rates near zero and pumped some $2.5 trillion into bond markets in aggressive moves that some — including a few Federal Reserve policymakers — worry could spike in inflation.

But prices have remained remarkably contained near the Federal Reserve's target rate of two per cent growth, allowing the central bank to continue monetary easing to ramp up economic growth and lower unemployment from its current level of 7.8 per cent.

Federal Reserve chairman Ben Bernanke and others have pointed to historically high joblessness as a major reason that wages have been so depressed. Workers cannot demand higher pay while there are so many others looking for jobs.

Yet in past economic recoveries, wage inflation started to pick up while unemployment was around seven per cent. And some economists believe average U.S. unemployment will not return to pre-recession levels closer to five per cent, meaning inflation could crop up earlier than expected.

"If the fear of inflation changes, the Fed will have to alter policy because the market will go nuts if it doesn't," said Jim Paulsen, chief investment strategist at Wells Capital Management, a unit of Wells Fargo & Co.

"The whole debate in this country about Fed policy would change overnight," Paulsen forecast, adding that he is not yet convinced about lasting growth in wages.

Recurring pattern

Average hourly earnings for production-based employees in the private sector jumped 1.7 per cent in December from one year earlier, according to government data that excluded workers in supervisory rolls.

That compares with rises of between 1.3 per cent and 1.4 per cent in the previous five months, suggesting a rebound from a possible bottom. Wage inflation over the last 30 years has averaged 3.2 per cent.

Last month's jump might be a one-off anomaly. There have been similar monthly rises in the last few years as wage inflation generally continued downward.

But if the rebound continues, it would closely mirror the pattern of recovery from the previous three U.S. recessions.

In the 1980s, 1990s and again in the 2000s, private sector wage inflation did not bounce back until three or four years after recessions ended in each of those decades. The latest recession ended in June 2009, just over three-and-a-half years ago.

That pattern caught the eye of Paulsen, who flagged it in a note to Wells Fargo clients. A sustained rise in wages, meanwhile, could help offset some U.S. austerity measures such as the payroll tax rise that kicked in this month.

Although the majority of Federal Reserve policymakers are committed to easy policies, a minority of them repeatedly warn that the central bank's growing stable of assets and year-after-year of rock-bottom rates could be dangerous.

In remarks on Thursday that stamped her as a hawk on the Federal Reserve's policy-setting committee, Kansas City Federal Reserve president Esther George said the easy-money policies could spark inflation. They "can just as easily aggravate unemployment as heal it," she said.

U.S. inflation has hovered between 1.3 per cent and 2.9 per cent over the last three years and is now near 1.5 per cent, according to the reserve's preferred inflation measure.

U.S. Treasury bonds dropped last week when minutes from the latest central bank meeting suggested the Federal Reserve could halt its large-scale asset purchases earlier than expected, highlighting how sensitive investors are to any suggestion of policy change.

'A blip or something more'

The wages at issue here are in mining, logging, manufacturing and construction, as well as in the vast services sector. The gauge that measures the wages accounts for about four-fifths of total employment in the closely watched non-farm payrolls report.

The jobless rate has gradually dropped over the last few years. Although there is intense academic debate over how much farther it can fall before sparking inflation, the Federal Reserve does not expect a rise above two per cent at any point over the next three years.

Furthermore, central bank policymakers said last month they would keep rates very low until unemployment fell to 6.5 per cent, as long as inflation forecasts stayed below 2.5 per cent.

The reserve's doubling down on the effectiveness of easy money policies has focused investors' attention on any signs of inflation, especially the so-called wage-push variety that has been absent through the current economic recovery.

Vincent Reinhart, chief U.S. economist at Morgan Stanley, said there should theoretically be a broader economic reaction to changes in wages because they are so "sticky," meaning they adjust very slowly to economic swings.

Wage inflation increased last month, but "other inflation indicators are not there," said Reinhart, a former director of monetary affairs at the Federal Reserve. "So market participants will have to decide whether this is a blip, or something more that they will have to be concerned about."

    
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