Important wage inflation measure for the Fed rose less than expected in Q4

Employment costs increased at a slower than expected pace in the fourth quarter, indicating that inflation pressures on business owners are at least leveling off.

The employment cost index, a barometer the Federal Reserve watches closely for inflation signs, increased 1% in the October-to-December period, the Labor Department reported Tuesday. That was a bit below the 1.1% Dow Jones estimate and less the 1.2% reading in the third quarter. It also was the lowest quarterly gain in a year.

Wages and salaries for the period also rose 1%, down 0.3 percentage point, while the cost of benefits increased just 0.8%, down from 1% in the previous period.

Compensation for government workers grew at a much slower pace comparatively in the quarter, slowing to a 1% gain from 1.9% in Q3.

Fed officials consider the ECI an important inflation gauge because it adjusts for occupations that are in higher demand and for outsized wage gains in particular industries, such as those that were most affected by the pandemic.

The Q4 reading comes the same day the interest rate-setting Federal Open Market Committee begins its two-day policy meeting. Markets have assigned a near-certainty to the FOMC approving a 0.25 percentage point rate hike before it adjourns Wednesday.

But the greater focus will be on what officials signal about the future of monetary policy.

Markets are anticipating one more quarter-point hike in March, followed by a pause and then one or two cuts before the end of the year. Fed officials have pushed back on the notion of any policy easing in 2023, though they could change their minds if inflation readings continue to abate.

“The Fed is still likely to keep raising interest rates at the next couple of meetings, but we expect a further slowdown in wage growth over the coming months to convince officials to pause the tightening cycle after the March meeting,” wrote Andrew Hunter, senior U.S. economist at Capital Economics.

The next big data point comes Friday, when the Labor Department releases its monthly nonfarm payrolls report.

Economists expect that payrolls increased by 187,000 in January, while average hourly earnings were projected to grow 0.3% monthly and 4.3% year over year, after increasing 4.6% at the end of 2022.