U.S. employment costs rose much faster than expected in the first quarter, driven by the largest quarterly rise in benefit payments since 1988.

That, says BMO Nesbitt Burns Inc. chief economist Sherry Cooper, suggests business must find cost savings elsewhere — “another reason the employment outlook remains under a dark cloud.”

In a report Tuesday, Cooper noted benefits have been steadily churning higher for years, largely owing to soaring medical care costs, and bubbled over in Q1 with a hefty 2.2% increase. This boosted the year-over-year increase in benefits to 6.1% from 5.0% in Q4. Beyond health care, the mounting costs to business of defined benefit pension plans are also weighing in.

The big rise in benefits pushed up the overall employment cost index by 1.3% in the quarter, well above expectations of a trend-like increase of 0.7%-to-0.8%. Benefits were not the only story in Q1, as wages and salaries also topped expectations with a healthy 1.0% advance, Cooper said. “This solid increase was led by the banking sector, where the mortgage-refinancing boom has translated into red-hot demand for workers. However, even with the large quarterly gains, the year-over-year trend in wages and salaries remained stable and moderate at 2.9%. Meantime, the total ECI rose 3.9% from a year ago, essentially matching the average annual increase over the past two years.”

Even with the sprint in benefit payments, employment costs pose precious little inflation threat. Productivity has surged by just over 4% in the past year, keeping unit labour costs close to unchanged. Average hourly earnings also remain very subdued at around a 3% annual pace, and the persistent weakness in hiring suggests that wage inflation will be no problem anytime soon.

On the positive side, Cooper said, the sizable gain in wages in Q1 suggests that household earnings may be poised for a turn.