updated 8/9/2005 5:48:47 PM ET 2005-08-09T21:48:47

Productivity growth turned in a solid performance in the spring while the pressure on labor costs eased significantly, the government reported Tuesday.

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The Labor Department said productivity — output per hour of work — rose at an annual rate of 2.2 percent in the second quarter. That was down from a 3.2 percent gain in the first three months of the year but remained high enough to guarantee continued increases in living standards, analysts said.

In good news for inflation, unit labor costs slowed to an annual increase of just 1.3 percent in the April-June quarter, substantially below the increases of the previous nine months that had raised fears of rising cost pressures.

While workers benefit from higher wages, the Federal Reserve closely watches the path of labor costs for early warning signs of mounting wage pressures that could foster inflation. Analysts said the slowdown in unit labor costs seen in the latest report will allow the Fed to continue nudging up interest rates at a gradual pace.

“These are OK numbers that indicate businesses are doing their best to keep down costs and keep up efficiencies,” said Joel Naroff, chief economist at Naroff Economic Advisors, a consulting firm in Holland, Pa.

The Federal Reserve announced Tuesday it was boosting a key short-term lending rate for the 10th time, pushing its target for the federal funds rate to 3.5 percent, the highest level in four years. In a statement announcing its action, the Fed said the economy was continuing to exhibit “robust underlying growth in productivity.”

On Wall Street, the Dow Jones industrial average ended three days of losses by rising 78.74 points to close at 10,615.67, reflecting investors’ relief that oil prices retreated a bit from Monday’s record highs.

Productivity has been surging in the years following the 2001 recession as American businesses laid off workers to hold down costs. While the huge productivity gains of the past three years are coming to an end, analysts believe productivity will remain strong enough to keep inflation in check.

“Usually coming out of a recession, you get a real spurt in productivity, which we got, but now things are settling down to what by historical standards are still very strong gains in productivity,” said David Wyss, chief economist at Standard & Poor’s in New York.

The slowdown in productivity growth from the super-sized numbers of past years reflects the fact that businesses have finally reached a point where they need to hire workers to keep up with demand for their products, a good sign for people looking for jobs. The government reported last Friday that payrolls grew by 207,000 workers in June, the strongest showing in three months.

The 2.2 percent rise in productivity in the second quarter was the smallest gain since a tiny 1.3 percent increase in the July-September quarter of last year.

The 1.3 percent increase in unit labor costs was the smallest gain since unit labor costs actually fell by 0.8 percent in the spring of last year.

With Tuesday’s report, the Labor Department lowered its estimates for productivity growth in the past three years to reflect revisions in the gross domestic product announced in late July.

Under the revisions, productivity grew by 3.4 percent last year rather than the previously reported 4 percent gain. Productivity growth in 2003 was lowered to 3.8 percent, instead of 4.3 percent, and 4 percent in 2002 rather than the previously reported 4.3 percent.

With slightly lower output per hour of work, unit labor costs were revised upward to 1.1 percent in 2004, instead of 0.8 percent; 0.2 percent in 2003 instead of a drop of 0.3 percent, and a drop of 0.3 percent in 2002 rather than a bigger decline of 0.8 percent, as was previously reported.

Higher productivity allows businesses to pay their employees more without raising prices for their products. That means the pay increases are not eroded by higher inflation.

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