ANALYSIS: Labor Cost, PCE Inflation Still a Challenge for Fed

--Mixed Bag of Data Shows Little Sign Inflation Breaking Out

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve officials looking for fresh signs that

labor costs or consumer inflation are breaking out of a pattern of sluggish

growth are likely to be frustrated by Friday's data. 

     Policymakers have said they expect a tighter labor market to eventually put

upward pressure on wages, but compensation has not picked up meaningfully even

as the unemployment rate hit new lows, the latest Labor Department report

showed. 

     It also came as no surprise that price levels in the second quarter rose at

a disappointing 0.9% rate, the smallest quarterly increase since 0.9% in the

first quarter of 2015, even as the latest data showed inflation last year was

slightly higher than previously thought. 

     Despite a tightening labor market, the employment cost index, a broad gauge

of employers' wage and benefit expenditures, rose at a seasonally adjusted 0.5%

rate in the second quarter, a bit less than analysts expected and failing to

carry forward a pick-up in momentum from the first quarter. 

     Over the past 12 months, the index held steady at 2.4% growth, the Labor

Department said, still at the high end of the post-recession range. Benefits

were up 2.5% on the year, rising faster than the 2.2% rate in first quarter and

continuing the gradual upward trend.

     "We expect upward pressure to build as the unemployment rate keeps falling,

but, for now, these data will be viewed as fairly benign by Fed officials," Jim

O'Sullivan of High Frequency Economics said in a note to clients Friday. 

     Friday's GDP report, which included annual revisions to data over the past

three years, offered a couple bright spots for officials. The economy revved up

in the second quarter as consumption picked up and business investment added

another 5.2% on top of the 7.1% gain in the first quarter. 

     The Fed's preferred measure of inflation, the core personal consumption

expenditures price index, was also revised a tenth higher last year to a 1.8%

annual rate. 

     Quarter-over-quarter, inflation was at or above the Fed's 2% target through

the first three quarters of 2016 before slowing to 1.3% in the final three

months of the year -- welcome news for policymakers. 

     But it is overshadowed by the softness in inflation in more recent months,

which the data again confirmed Friday. 

     Second quarter core PCE prices were up 1.5% from a year earlier, after a

1.8% rise in the first quarter and 1.9% gain in the fourth quarter. That is the

smallest gain since the fourth quarter of 2015, when core PCE prices rose just

1.3%.

     The Federal Open Market Committee this week stuck to its outlook for

inflation to return to target over the medium term even as it acknowledged

inflation had declined in recent months. 

     But if that weakness persists, the Fed may find itself pushing the next

rate hike until 2018. 

     As Chair Janet Yellen told Congress this month: "We're watching this very

closely and stand ready to adjust our policy if it appears that the inflation

undershoot will be persistent."

     The Labor Department will release the PCE report for June on Tuesday. 

     Vs Prev Qtr        Vs Year Ago

            1Q17  2Q17         1Q17  2Q17

-----------------------------------------

ECI          0.8   0.5          2.4   2.4

                        Vs Prev Qtr

                               2Q16  3Q16  4Q16  1Q17  2Q17

-----------------------------------------------------------

Headline PCE Inflation          2.1   1.7   2.0   2.2   0.3

Core PCE Inflation              2.0   2.0   1.3   1.8   0.9

                        Full Year              4Q/4Q

                             2014  2015  2016   2014  2015  2016

----------------------------------------------------------------

Headline PCE Inflation        1.5   0.3   1.2    1.2   0.4   1.6

Core PCE Inflation            1.6   1.3   1.8    1.5   1.3   1.9

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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