By Mark Egan
WASHINGTON (Reuters) - A raft of data released on Tuesday underscored the weakness of the U.S. economy with productivity falling, labor costs rising at a troubling pace and signs of slowing activity in both the manufacturing and service sectors.
The reports were the latest in a series that have shown the severity of the recent deceleration in the world's richest economy, something the Federal Reserve has tried to counter with deep interest rate cuts.
The Labor Department's latest report on worker productivity highlighted a conundrum facing the U.S. central bank at its next interest-rate setting meeting at the end of this month. While the fall in the productivity of U.S. workers argues for further aggressive cuts in interest rates to foster economic growth, the potential for inflation implied by rising labor costs argues for a more cautious approach.
Productivity of U.S. workers -- the growth of which helped to keep inflation in check during the bumper years of 1999 and 2000 -- logged its sharpest fall in eight years in the first three months of the year. And signs of wage pressure emerged with unit labor costs posting their largest gain in more than a decade.
The productivity of workers outside the farm sector fell at an annual rate of 1.2 percent during the first three months of the year. That was much weaker than Labor's previous estimate of a 0.1 percent decline and followed a gain of 2 percent seen during the final three months of last year.
Unit labor costs -- a key gauge of inflation pressures -- soared at a 6.3 percent annual pace after a 4.5 percent advance during the last three months of last year.
"Productivity has been one of the centerpieces of the whole New Economy gains that we saw over the last couple of years with respect to being able to have strong growth and low inflation, so the drop in productivity deepens...anxiety that the strong growth-low inflation scenario won't be as dominant a trend as it has been in recent years," said Kim Rupert, senior economist at Standard & Poor's MMS.
The rise in labor costs was greater than the government's earlier estimate that they rose at a 5.2 percent annual pace in the January to March period, and was the largest gain since a 6.8 percent spike in the last three months of 1990.
CENTERPIECE OF NEW ECONOMYProductivity, which measures the amount of goods and services workers produce per hour and is crucial to rising living standards, has fallen steadily in recent quarters.
When workers' productivity grows, companies can produce more while holding down costs. The first-quarter decline in productivity was the steepest falloff since a 5.0 percent slump during the first three months of 1993.
Many economists believe the productivity downturn is a cyclical dip that will reverse as soon as economic growth picks up. Still, they found the surge in unit labor costs troubling.
"There is some concern," said Michael Swanson, senior economist at Wells Fargo bank in Minneapolis. "You just can't see those kind of wage increases without productivity and not see it reflected in the price of goods and services later on."
The numbers were broadly in line with Wall Street expectations. Economists polled by Reuters had forecast productivity would fall by 0.8 percent and unit labor costs would rise by 6 percent in the first three months of the year.
MANUFACTURING FLOUNDERSA separate Commerce Department report said new orders received by U.S. factories fell sharply in April, hit by weak demand for new cars, computers and primary metals used by the nation's floundering manufacturing sector.
The value of factory orders plunged 3 percent, more than expected, to a seasonally adjusted $336.94 billion in April, the first decline since January. The report implied a poor start to second-quarter economic activity because output typically declines in the face of fewer orders.
Adding to the bleak picture, a gauge of U.S. service sector activity for May suggested for a second straight month that manufacturing is not the only area of the economy shrinking.
The National Association of Purchasing Management on Tuesday said its monthly non-manufacturing index fell to 46.6 in May, its lowest reading in the survey's four-year history and its second straight month below 50.
A reading below 50 indicates contracting economic activity in services, made up of key sectors such as transportation, legal services, real estate and business services.
Joel Naroff, president of Naroff Economic Advisors, said of the combined reports, "We have nothing here that says to the Fed that you can sit around and watch and wait."
With activity slowing in the manufacturing sector and elsewhere, productivity falling and costs rising, businesses are being forced to cut spending and lay off workers as profits are being squeezed.
Naroff said that the Fed would likely cut interest rates by another quarter of a percentage point when it meets on June 26 and 27, with the possibility of another cut in August.
The data had little impact on prices for U.S. Treasuries. Stocks opened modestly higher and continued to post gains in midday trading with the Nasdaq up about 3 percent, buoyed by corporate news.