In the waning months of the previous year, the growth of pay and benefits for American workers experienced a deceleration, marking the slowest pace in two and a half years. This trend may bear significance for the Federal Reserve’s deliberations on when to initiate interest rate cuts.
As per the Labor Department’s Employment Cost Index, compensation increased by 0.9% in the October-December quarter, down from a 1.1% rise in the preceding quarter. In comparison to the same quarter of the previous year, compensation growth decelerated from 4.3% to 4.2%.
While the uptick in wages and benefits remained generally healthy, the slowdown may contribute to a moderation in inflation, a development likely to be welcomed by Federal Reserve policymakers. Despite expectations that the Fed will maintain its key short-term rate after the latest policy meeting, there is speculation that it might signal a propensity to cut rates later in the year.
James Knightley, chief international economist for European bank ING, remarked, “Not great news for our paychecks, but good news for inflation and the prospect of meaningful” interest rate cuts by the Fed.
Although the Federal Reserve has indicated an intention to lower its benchmark rate in the coming year, the timing of this decision remains uncertain, eagerly anticipated by investors and businesses alike. The sluggish wage gains could potentially make the Fed more amenable to cutting rates as early as March, according to economists, although the majority foresees the initial cut occurring in May or June.
A reduction in the Fed’s rate typically leads to a decrease in the cost of mortgages, auto loans, credit card rates, and business borrowing.
The pace at which worker compensation grows significantly influences businesses’ labor costs. Rapid increases in pay can lead to heightened labor costs for companies, prompting them to raise prices. This cycle has the potential to sustain inflation, a factor that the Fed considers in determining when to adjust its influential benchmark rate.
Despite wages having grown at an historically brisk pace, on average, since the onset of the pandemic, hiring has recently moderated, approaching levels seen before the global health crisis. The tempered job gains have lessened the pressure on companies to offer substantial pay increases.
The Employment Cost Index (ECI) holds particular importance for the Federal Reserve as it gauges changes in wages and benefits for the same sample of jobs. This distinguishes it from other measures, such as average hourly pay, which may be artificially influenced by factors like widespread layoffs among lower-paid workers.
Even with the slowdown in wage increases, inflation has also declined, resulting in improved pay gains for Americans after adjusting for rising prices. Accounting for inflation, pay rose by 0.9% in the fourth quarter of the previous year compared to a year earlier, up from a 0.6% annual gain in the preceding quarter.
The peak in pay and benefits growth, as measured by the ECI, occurred at 5.1% in the fall of 2022. However, during that period, inflation was rising more rapidly than it is now, diminishing Americans’ overall buying power. The Fed’s objective is to curb inflation so that even smaller pay increases can translate into inflation-adjusted income gains.
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