Productivity bump another step toward inflation hope

US worker productivity gains running well above the long-term average may help buttress the Federal Reserve’s (Fed) faith that inflation is contained and further open the door to interest rate cuts policymakers anticipate will start in coming months.

Output per worker, a key gauge of how fast the economy can grow without rising inflation, increased 3.2% in the last quarter of 2023, the third quarter of productivity gains above 3% in a series that averaged about 1% from 2010 through 2019.

Fed chair Jerome Powell spoke at his press conference about the advantages rising productivity holds for the Fed’s inflation fight, offering the prospect of more jobs and stronger economic growth with less pressure on prices.

But while the productivity numbers may be more an explanation of why inflation has been falling as opposed to a signal about what comes next, Powell no longer says the economy needs to go through a period of sluggish, below-potential growth for the pace of price increases to decline from a level still described by the Fed as “elevated.”

The need for weak growth to cool inflation had been a working premise of Fed policy for much of its fight against rising prices.

Its disappearance from Powell’s rhetoric points to some faith that output per worker will remain healthy, and unit-labour costs will stay muted. Beyond lowering inflation pressures, rising productivity leaves more room for wage gains since each worker hour is providing more goods and services.

“Whereas a year ago we were thinking that we needed to see some softening in economic activity that hasn’t been the case. We don’t look at it as a problem,” Powell said.

“I think at this point, we want to see strong growth, we want to see a strong labour market. We’re not looking for a weaker labour market. We’re looking for inflation to continue to come down as it has been coming down for the last six months.”

The Fed at its meeting this week finished a policy evolution that began last year, removing a presumption of further rate hikes in favour of a neutral stance and an acknowledgment that rates could fall once policymakers are more confident inflation will continue moving toward its target.

“The committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%,” the Fed said in its statement.

Investors expect a first rate cut in May, but on the way there policymakers will have to make a judgment – and likely reflect it in public comments – that the pace of inflation is no longer elevated.

That may just be a matter of time. While the Personal Consumption Expenditures (PCE) price index used by the Fed to set its target was last at 2.6% on a yearly basis, the eight-month pace since April annualises to a below-target 1.9%.

Powell said he did not think there will be enough data in hand by the March 19-20 meeting to reduce rates. But by the April 30-May 1 meeting policymakers will have received a full suite of first-quarter data on consumer inflation, PCE, jobs, wages and an estimate of economic growth for the first quarter of the year.

All will be watched as policymakers consider when to finally remove the word “elevated” from the description of inflation in their policy statement.

Also important are survey and market measures of inflation expectations. Reuters