Originally Published: 28 JUL 23 08:38 ET

Updated: 28 JUL 23 09:44 ET

By Bryan Mena, CNN

Washington, DC (CNN) — US wage gains cooled in the second quarter, showing some easing of inflationary pressures, according to data from the Bureau of Labor Statistics released on Friday.

Wages and benefits paid to US workers rose 1% in the second quarter from the prior one, a slightly weaker pace than the 1.2% gain in the first three months of the year.

The Employment Cost Index, a comprehensive measure of employers’ compensation costs, advanced 4.5% in the second quarter from a year earlier, a slower pace than the 4.8% rise earlier in the year.

Why stronger wage growth isn’t great for the Fed

Although fatter paychecks are great for workers, unusually strong wage growth can feed into inflation and can lead to interest rates hikes from the Federal Reserve.

The weaker second-quarter wage figures are a positive sign for the Fed, which is trying to cool the economy and bring the labor market into better balance to fight inflation still running well above the central bank’s 2% target.

The Fed raised its benchmark lending rate by a quarter point this week, but officials maintained a hawkish posture, suggesting that one more rate hike remains on the table. The timing of that last rate increase is unclear, but Fed officials underscored the importance of upcoming economic data in that decision.

In a separate report released Friday, the Fed’s preferred inflation gauge — the Personal Consumption Expenditures price index — rose 3% for the 12 months ended in June, a cooldown from the 3.8% rate posted in May, while the core index slowed to a 4.1% rate from 4.6% during the same period.

Friday’s ECI report and the weaker inflation reading for June help make a case for holding rates steady.

Monitoring the tight labor market

The Fed is closely watching the state of the labor market because of the role that higher labor costs play in pushing up consumer prices. Demand for workers remains high, with job openings still hovering above pre-pandemic levels, though they have tumbled from a record high reached last year.

That has prompted employers to raise wages to successfully lure talent, especially among some labor-intensive service-providing businesses that have struggled to hire qualified workers. Those costs are typically passed on to consumers, feeding into inflation.

But the job market has cooled in the past several months as job openings declined while the share of people employed or seeking work increased, so some of those dynamics have been slowly unwinding.

“This report is a reflection of the fact that wage growth is slowing as the labor market cools, so we’re in a different spot today than in the start of the second quarter when we were still coming off a wave of high-profile layoffs, especially in the tech sector and significant anxieties about a recession,” said Daniel Zhao, lead economist and senior manager at job site Glassdoor.

It remains to be seen whether inflation can drift all the way to 2% without a substantial weakening in the labor market. Such a scenario would be considered a soft landing, and investors have grown more confident that the Fed can pull that off. But inflation’s recent slowdown has been encouraging for American consumers and businesses this summer. According to the University of Michigan’s latest consumer survey, consumer sentiment rose 8% in June from the prior month.