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Inflation, Services Show Improvement

Hopes for a "soft landing" of the economy got a boost after reports showed weaker-than-expected inflation and a stronger services sector.

Unit labor costs--a key inflation measure--rose at an annual rate of 2.3% in the third quarter, the Labor Department said. That was much slower than the 3.8% pace reported a month ago. As a result, labor costs have actually eased from the second quarter, not worsened as predicted.

Meanwhile, an index of activity in the services sector rose to 58.9% in November, the highest level since May. The index, by the Institute of Supply Management, was expected to have declined last month.

Federal Reserve officials, who closely watch unit labor costs, have been warning about the dangers of inflation and downplaying weakness in the economy. These latest reports suggest that while inflation may appear tame, the economy is still showing signs of strength.

While stocks rose on the economic data, not everyone is as sanguine. In an exclusive interview with cnbc.com, PIMCO Chief Investment Officer William Gross said the economy remains weak and that the Fed will have to cut interest rates sometime in the next year.

"We continue on with our outlook for slower economic growth in the U.S. and the rest of the world," Gross said.

He also downplayed the improvement in the services sector. "The last time we had a recession, in 2000 and 2001, the service number didn't break (below) 50 until the recession began, and it lagged the manufacturing sector breaking 50 by nine months," Gross said. Any number below 50 is an indication of a contraction in activity.

Gross expects Fed officials will have to change their tone the economy and consider a rate cut once unemployment numbers begin to creep up. The latest employment data for November will be reported Friday.

Separately, there were additional signs of weakness in manufacturing, with the Commerce Department reporting factory orders fell 4.7%, after a revised 1.7% gain in September. Durable goods orders also declined, although at a slightly slower pace than originally reported.

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