Productivity Stronger Than Expected; Labor Costs Rise in Second Quarter

The productivity of U.S. businesses rose at a swifter-than-expected pace in the second quarter but labor costs still gained at their fastest rate in two years, the government said on Tuesday.

Nonfarm business productivity rose at a 2.9 percent annual rate in the second quarter, the Labor Department (search) said, well ahead of the 2 percent gain expected by Wall Street.

Despite the solid efficiency gains, the cost of labor per unit of production increased at a 1.9 percent clip as hourly compensation, which includes both wages and benefit costs, climbed at a sharp 4.9 percent rate. The rise in unit labor costs was just below the 2 percent increase forecast by private economists.

Because labor represents the biggest production expense for businesses, the rise in unit labor costs suggests worker compensation could begin eroding profits, unless firms can raise their selling prices.

The latest data offers a reminder to officials at the Federal Reserve (search), who gather on Tuesday to mull interest-rate policy, that cost pressures could be slowly building.

However, any sting from the latest rise in unit labor costs was tempered by a downward revision to the measure for the first quarter, which was lowered to a 0.3 percent advance from the previously reported 0.8 percent gain.

Most analysts expect Fed officials to raise overnight borrowing costs by a quarter-percentage point to 1.5 percent on Tuesday, although some think the central bank may hold its fire in the wake of a weak report on jobs creation released on Friday.

The Fed is expected to announce its decision at about 2:15 p.m.