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Economists worry rising wages may catch the Fed off guard

By Lucia Mutikani

WASHINGTON (Reuters) - Wages may be growing at a faster clip than envisaged by U.S. policymakers, with a recent raft of business surveys showing an increase in the number of companies raising compensation.

One closely watched wage growth measure, a gauge produced by the National Federation for Independent Business, has reached a seven-year high. A turn in this index, which began moving up late last year, historically has been followed by a pick-up in wage growth nine months later.

That and evidence of a tightening labor market has some economists worried the Federal Reserve may miss the signs of accelerating wage growth and end up with an inflation problem.

"The biggest threat to the Fed's policymaking is that six years of not having to deal with wages doesn't allow you to understand how wages will change when you come back to a more normal full-employment type of economy," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

"When the dam breaks, it breaks and you don't necessarily see a slow rise in compensation."

Fed Chair Janet Yellen told Congress last week she would keep monetary policy loose until hiring and wage data show the lingering effects of the financial crisis are "completely gone."

"While rising compensation or wage growth is one sign that the labor market is healing, we are not even at the point where wages are rising at a pace that they could give rise to inflation," she said.

But some economists are skeptical.

The NFIB gauge is closely correlated with the government's employment cost index, a broad measure of wage growth and one of Yellen's favorite indicators.

These economists expect the ECI to start pushing higher in part thanks to a narrowing of the gap between the unemployment rate and a broader measure of labor market slack, which includes people who want a job but have given up searching and those working part-time because they cannot find full-time jobs.

The unemployment rate is near a six-year low of 6.1 percent, while the so-called U-6 measure reflecting the broader band is at 12.1 percent. Both have come down from peaks of 10 percent and 17.2 percent respectively.

SKILLS GAP POCKETS

While average hourly earnings, the most widely quoted measure of wages, shows tepid growth, compensation is quickening in areas such as financial services, mining, information and trade as well as transportation and utilities.

The Fed's latest Beige Book found that while wage pressures were modest in most districts, they were rising in sectors such as construction and energy, where employers were struggling to find qualified workers. It said increases in the minimum wage in some parts of the country were also pressuring wages.

While average hourly earnings gains are up just 2 percent over the last year, aggregate wages for production and non-supervisory workers, which include overtime, are up 4.6 percent.

More startlingly, this aggregate measure, which some economists view as a better gauge of wage growth, is up at a 6.2 percent annual rate over the past three months.

"The labor market is a lot tighter and wage pressures are probably going to be more intense than the Fed thinks," said Jacob Oubina, senior U.S. economist at RBC Capital Markets in New York.

The NFIB data is buttressed by other business surveys that suggest workers are beginning to win higher pay.

The National Association for Business Economics reported this week that 43 percent of its members increased wages in the three months to July, up from only 19 percent in the comparable period last year.

A recent chief financial officers survey by Duke University's Fuqua School of Business and CFO Magazine found U.S. companies in the second quarter expected to raise wages and salaries by 3 percent over the next 12 months. When CFOs were surveyed a year ago, they expected increases of 2.5 percent.

Some economists also argue the retirement of Baby Boomers makes average hourly earnings a less reliable gauge of wage pressures. Most of these retirees earned higher salaries and their positions are in most cases being filled by college graduates who are coming in at lower salaries.

In the view of these economists, the demographic shift means hourly earnings today cannot be compared to previous recoveries.

"I am not sure that the yard stick (Fed officials) are using to measure what is appropriate wage growth is fair, they may be using past cycles as their standard," said Ray Stone, an economist at Stone & McCarthy Research Associates in Princeton, New Jersey.

"If that's their standard we might end up with policy kept too easy too long."

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama)

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