Improving productivity and ULC data should help reduce inflation fears

Today's productivity and labor cost results for the first quarter of 2007 were much better than expected, according to the preliminary data, and will help reduce inflation concerns.

First quarter productivity was +1.7% (consensus +.7%), and the fourth quarter results were also revised higher to +2.1% from +1.6% previously reported. The surprise improvement is based on drop in hours worked, which is at odds with other reports, and calls into question the productivity gains reported today. Fourth quarter productivity was enhanced by an increase in output produced.

Manufacturing productivity, which tends to more variable than the larger non-farm business sector, was +2.7% in the first quarter of 2007. The growth reflected a 1.5% increase in output and a 1.1% decrease in hours worked in manufacturing.

Unit labor costs unexpectedly rose only +.6% (consensus +3.8%). This is a substantial deceleration from the revised 6.2% of the prior quarter, which was boosted by one time bonus and stock option exercises. Compensation per hour fell from an +8.5% gain in the fourth quarter to +2.3% in the first quarter. It is probably more fair to average the two numbers due to how the government accounts for the timing of bonus accruals versus payments, and would equate to around 3.5% annualized, which is above the core inflation rate. Unit non-labor costs rebounded in the first quarter to increase +7.6% after falling -7.9% in the prior period. Unit labor costs adjust wages and benefits per hour worked for output produced. So, higher productivity helps reduce unit labor costs.

The implicit price deflator, which reflects changes in costs, grew at a 3.2% pace in the first quarter, versus a slim +.5% gain in the fourth quarter. On a year-over-year basis, the price deflator is running at 2%.

On a year-over-year basis, productivity has fallen to +1.1% in the first quarter of 2007, versus +2% in the first quarter of 2006. Current productivity levels remain below the trend of the last decade. Efficiency tends to drop when the economy contracts because workers are retained while production slows. Unit labor costs have also declined over the same period from +3.6% YoY in the first quarter of 2006 to +1.3% YoY presently.

Net - rising productivity and falling unit labor costs are good for business.

**********
Initial jobless claims unexpectedly fell to 305k from 326k last week. This survey week was after the payroll data survey for April employment.