Unit labor costs for the second quarter were revised sharply higher, to an annual increase of 2.5% from a preliminary 1.3%. The revised year-on-year rate edged down one tenth but is still very high at 4.2% - still the highest in five years.
The upward revision in quarter-to-quarter labor costs reflects a downward revision to quarter-to-quarter output growth, at a 4.1% annual rate vs. a preliminary 4.4%.
Slowing output growth and rising wages spell lower productivity, which was revised four tenths lower to 1.8%. Year-on-year productivity growth was unchanged at a moderate annual rate of 2.2%.
Strong productivity has been at the heart of the four-year economic recovery and is the preamble to each FOMC statement. Today's revision, together with ongoing job growth, suggest that productivity may be on the slowdown, a negative for all financial markets. The immediate effects of Katrina, however, diminish the importance of prior economic data. Bonds, always sensitive to the risk of wage-push inflation, did dip slightly in reaction to the report, which otherwise is unlikely to have a significant impact on today's markets.
Morgan Stanley Cuts Global Growth Forecast
The global and European growth outlook does not give reasons for optimism either. Morgan Stanley cut their forecasts for 2006 significantly, citing higher inflation of around three percent in Europe in 2006. From their report:
We are cutting our global and European GDP growth forecasts for 2005 and 2006, on the back of higher-than-expected crude oil and refined product prices. As for 2005, better-than-expected Q2 GDP results would have raised our full-year GDP forecast to 1.3%. We are bringing it back to 1.2%. As for 2006, the same base effect would have raised our GDP forecast to 2.1%. We are cutting it by four-tenths to 1.7%. Overall, we are slicing half a percentage point from our 2005-06 growth forecasts.US Treasury Sees Slower Growth Ahead
At this stage, we believe that the inflationary consequences of higher energy prices will be short lived and that Europe will continue to benefit from two powerful shock absorbers, strong corporate profitability thanks to persistent wage moderation, and buoyant exports to oil producers. Accordingly, the probability of a full-blown recession is low, in our view. For these reasons, we believe that the ECB will not alter its "normalisation" agenda and we continue to anticipate a first step in early 2006.
While Morgan Stanley has yet to come to a conclusion about the future fate of the US economy, Tresaury Secretary John Snow sees already tougher times ahead. According to Bloomberg, Snow, citing private forecasts, said yesterday that "it would seem to make sense'" that higher energy prices, lost jobs and closed businesses stemming from Hurricane Katrina may slow U.S. economic growth by about 0.5 percent "in the quarters ahead."
Conclusion: Inflation and interest rates will rise over the coming months.