U.S. factory orders plunged in January

/ Source: The Associated Press

The economy is still caught between slowing growth and stubborn inflation pressures, new government reports showed Tuesday.

Labor costs, boosted by bonuses to high-income workers, soared at the end of last year, raising inflation worries, while factory orders plunged in January by the biggest amount in 6½ years.

The reports, analysts said, highlighted the difficulties the Federal Reserve faces as it is confronted by the opposing forces of slowing growth and rising inflation.

The Labor Department reported that productivity, the amount of output per hour of work, rose at an annual rate of 1.6 percent in the October-December period last year, just about half of the original estimate.

But the cost of the labor needed to produce each unit of output soared by 6.6 percent, far higher than the 1.7 percent initial estimate and well above the 3.2 percent increase Wall Street was expecting.

The worry is that the combination of lower productivity and higher wages would make inflation worse and keep the Fed from cutting interest rates even though certain sectors of the economy such as housing and manufacturing have been hard-hit by the current economic slowdown.

The Commerce Department reported that factory orders dropped by 5.6 percent in January, the biggest decline since July 2000, when the economy was slowing sharply in advance of an actual recession that began in 2001.

The government said orders for big-ticket durable goods plunged by 8.7 percent, even bigger than the 7.8 percent drop originally reported a week ago. That initial report had jolted investors and contributed to last week’s 416-point one-day drop in the Dow Jones industrial averages.

Wall Street, however, took the new reports in stride. Stocks rebounded as investors were encouraged by a recovery on world markets.

The Dow Jones industrial average rose by 157.18 points, after having dropped 581 points over the past week, to close at 12,207.59. It was the biggest one-day point gain since July 24.

The weakness in manufacturing was led by a 19 percent fall in orders for transportation products, reflecting a 6.7 percent drop in the struggling auto industry and a 60.2 percent plunge in demand for commercial airplanes. Demand was also down for primary metals, machinery and computers.

Orders for nondurable goods, items such as petroleum and food, fell by 2 percent in January after a 1.5 percent increase in December.

The weaker productivity number reflected the big downward revision announced last week in total economic growth, as measured by the gross domestic product. The GDP expanded at a sluggish 2.2 percent annual rate from October through December, not the 3.5 percent growth rate originally reported.

With less output and the number of hours worked remaining the same, productivity for the quarter looked worse. The drop in output also meant that unit labor costs were higher.

It was the biggest quarterly increase in labor costs since a 9.1 percent surge in the first three months of 2006. Both gains were attributed in large part to big bonuses paid to high-income workers.

Analysts said this report would certainly attract attention at the Fed and would add to the view that even with the economy slowing, policymakers cannot consider cutting interest rates.

“Three sluggish quarters of economic growth should have created an environment for an ease, but with cost pressures rising, inflation concerns have to remain high,” said Joel Naroff, chief economist at Naroff Economic Advisors, a private forecasting firm.

Many economists believe the Fed will leave rates unchanged when they next meet on March 20-21 and could leave rates alone for the rest of the year. The Fed’s last move was a 17th consecutive increase in the federal funds rate last June.

Productivity is the key element needed for rising living standards. It allows businesses to pay workers with the wage gains financed by the increased output. Without productivity gains, businesses often have to resort to boosting the cost of their products to finance wage gains, a process that increases inflation.

Beginning in 1973, productivity slowed dramatically as the country went through a period of high inflation, triggered by a series of oil shocks. However, productivity started to show much better gains in the mid-1990s as the economy benefited from increasing use of computers.

For all of 2006, productivity rose by 1.6 percent, the slowest annual increase in nine years.