(Bloomberg) -- US employment costs rose at a slower-than-expected pace in the closing months of 2022, adding to signs of moderating inflation that reinforces the case for a smaller interest-rate increase by the Federal Reserve this week.

The employment cost index, a broad gauge of wages and benefits, increased 1% in the fourth quarter, according to Labor Department figures released Tuesday. Labor costs have risen at least 1% for six straight quarters, extending what was already a record streak in data back to 1996.

The median estimate in a Bloomberg survey of economists called for a 1.1% advance. The S&P 500 opened higher and Treasury yields declined after the report.

The data are consistent with other measures that show wage growth is slowing, though still not enough for the Fed to feel confident that such inflationary pressures have been quelled for good. Policymakers have been adamant that their work is far from over, which could lead them to keep interest rates high for an extended period of time.

The release comes at the start of the Fed’s two-day policy meeting, at which officials are expected to slow the pace of rate hikes to a quarter point. However, Chair Jerome Powell will likely balance that with a still-hawkish tone and push back on bets that the central bank will lower borrowing costs this year.

Powell has been particularly concerned with inflation in services outside of energy and housing, which points to signs of more durable price pressures and largely reflects wages. Inflation in that category ticked up last month, though broader measures, which the Fed bases its inflation targeting, continued to cool, Commerce Department data released last week showed.

The moderation in compensation gains last quarter was mainly due to a stepdown in employment costs at service providers. 

What Bloomberg Economics Says...

“The moderation in fourth-quarter ECI indicates more disinflation in the pipeline for core services. Slower wage growth likely bolsters Fed officials’ confidence that they should slow the pace of rate hikes, but it won’t stop them from taking rates to at least 5%.”

— Anna Wong, economist

To read the full note, click here

Unlike the earnings measures in the monthly jobs report — which is forecast to show this week that average hourly earnings moderated in January — the ECI is not distorted by employment shifts among occupations or industries. 

Compared with a year earlier, the labor costs measure rose 5.1%, a slight pickup from the prior period. However, excluding incentive-paid occupations — a measure the Fed tracks closely — employment costs decelerated.

Labor costs have mostly been receding from record highs as turnover eases and several employers slow hiring or dismiss staff. The Atlanta Fed’s wage growth tracker decelerated to 6.1% in December, the lowest in seven months.

However, many companies are still struggling to attract and retain workers. Walmart Inc. the largest private-sector employer in the US, is raising its starting wage 17% amid inflation and heightened competition for workers, and Citigroup Inc. is bumping pay for junior bankers by as much as 15%.

Read more: Goldman Costs Surge on Pay, Add to Pain of Shrinking Revenue

Wages and salaries for civilian workers rose 1% in the final three months of 2022, while benefits climbed 0.8%, the ECI report showed. Pay at state and local governments increased at less than half the rate as the prior quarter.

Pay has largely not kept up with inflation, inflicting financial stress on many households. Inflation-adjusted consumer spending fell in December for a second month and the saving rate rose, suggesting Americans may be preparing for tougher times ahead.

How Executives See It

“Employers continue to add jobs and wages are growing, so demand for our services and offerings should remain robust.” — J. Patrick Gallagher, CEO of Arthur J. Gallagher & Co., Jan. 26 earnings call

“Labor costs have gone up structurally, and as we grow, they’re going to continue to go up as we hire more people to fund that growth.” — Ben Minicucci, CEO of Alaska Air Group Inc., on Jan. 26 earnings call

“We anticipate higher labor and benefit costs and other timing related expenses that occur at the beginning of a new year, as well as higher prices for many chemicals.” — Mark W. Kowlzan, CEO of Packaging Corp. of America, on Jan. 26 earnings call

There are signs the labor market is already softening. Layoffs are mounting in the tech and banking sectors, and many of those companies are slashing bonuses as well to cut costs further, especially for senior executives.

For now, the job market is still extremely tight, according to Powell and his colleagues. Vacancies likely stayed well above 10 million last month, ahead of data to be released Wednesday, while data out Friday is expected to show still historically low unemployment and strong hiring.

While economic growth beat expectations in the last quarter of 2022, there were underlying signs of weakening demand that suggest a recession remains a big risk this year. That may help keep a lid on future wage growth.

--With assistance from Jordan Yadoo, Augusta Saraiva and Reade Pickert.

(Add Bloomberg Economics comment, updates with market open)

©2023 Bloomberg L.P.