U.S. Labor Costs Signal Potential Fed Interest Rate Cut

U.S. labor costs saw a moderate increase in the second quarter, with private sector wage growth at its slowest pace in 3-1/2 years. This confirms a downward trend in inflation, possibly prompting the Federal Reserve to consider an interest rate cut in September.

U.S. labor costs increased moderately in the second quarter as private sector wages grew at the slowest pace in 3-1/2 years, more evidence that inflation was firmly on a downward trend and could help facilitate an interest rate cut in September.

The report from the Labor Department on Wednesday followed data last week showing inflation subsided considerably last quarter, with sub-3% readings in all the measures. Federal Reserve Chair Jerome Powell welcomed the tamer labor costs reading and told reporters on Wednesday "our confidence is growing" that inflation is slowing and "the economy's not overheating."

The U.S. central bank kept its benchmark overnight interest rate in the 5.25%-5.50% range. Fed officials, including Chief Economist Christopher Rupkey, noted that wage increases are now more in line with expectations, making rate cuts more likely. Labor costs advanced 4.1% in the 12 months through June, the smallest gain since the fourth quarter of 2021.

Economists polled by Reuters had forecast the ECI would rise 1.0%. The ECI increased 0.9% last quarter after a previous rise of 1.2%. Stocks on Wall Street were trading higher, and U.S. Treasury yields fell. Price pressures are ebbing following 525 basis points worth of rate hikes from the Fed since 2022.

Wages and salaries, which account for the bulk of labor costs, increased 0.9% last quarter. This was the smallest advance in three years. Economists see the cooling labor costs as a positive sign for the economy and consumer spending. Private sector wages and salaries climbed 0.8%, the smallest advance since late 2020, reinforcing the narrative of a cooling labor market.

Union and non-union wages demonstrated varying trends, with union workers seeing a 6.5% increase and non-union workers a 3.8% rise. Sectoral variations also showed construction wages dropping while services sector wages gained. Additionally, health benefits for private workers surged 3.6% year-on-year.

State and local government wage gains rose 1.1% after shooting up 1.4% in the first quarter. Benefits for all workers rose 1.0% after increasing 1.1% in the January-March quarter. Contracts to buy previously owned homes rebounded 4.8% in June but affordability challenges persist. Elevated mortgage rates and high home prices will act as headwinds, although increasing inventories and possibly lower borrowing costs could boost future home sales.