(FORTUNE Magazine) – When the recovery gets going this spring, the hopes for good times will be dashed on at least one count: Neither the drag of recession nor rising unemployment has defeated inflation. The culprit is an intractable set of conflicting demands: Employees need to make up for lost income, and businesses must repair devastated profit margins. There's only one way for both to get satisfaction, and that is to charge more. Largely as a result, consumer prices will rise nearly 5.5% during the coming year, little better than the oil- shocked 6% of 1990. The gauges are hard to read now because distortions are pushing the indexes both up and down. Take February's slow 2.7% annual rate of increase in consumer prices. Food and energy, even more volatile than usual, provided most of the relief. Heating oil and gasoline jumped last summer on the expectation of imminent shortages. In large part the low February inflation reflected the unwinding of those increases. Food prices helped too, falling after a drought- induced spurt in January. But the good news has largely run out. Gasoline has declined about as much as it is going to, barring an unlikely collapse in crude oil. Prices stabilized late in March at $1.13 per gallon for unleaded regular gas at self- service pumps (including the recent 5-cent tax increase), vs. $1.03 the year before. And food prices will move up in coming months, following a turnaround in the wholesale cost of food commodities. Meanwhile, hidden by the gyrations in food and energy, prices for all other consumer goods and services have advanced at a startling 9% annual rate so far this year. Some of those increases are transient. Analysts looking for a bright side are quick to point out that higher excise taxes on tobacco and alcoholic beverages were a one-time boost in the price level and shouldn't be confused with a continuing pace of change -- meaning inflation. And spring came sooner than usual in clothing stores as merchants stocked up for the early Easter. So large increases in apparel prices in February as well as in January, mostly a fiction of bad seasonal adjustments, will soon be reversed. But leaving aside the special factors will get the so-called core consumer inflation back only to the 4.5% pace of the previous quarter. THE PUSH from labor costs will build from that base. Businesses have been successful in holding down wages -- which, not so incidentally, provide consumers the wherewithal to spend -- during most of the long expansion of the Eighties. Now they will have to yield a bit. Because pay increases have trailed inflation for years, employees have a powerful incentive to catch up. They will press harder, and more successfully, for raises as the recovery gains momentum. For all private businesses, hourly compensation including benefits should increase almost 5% during 1991 and a bit more next year, vs. 4.4% for 1990. Few companies are likely to give away the store. David Lewin, director of UCLA's Institute of Industrial Relations, sees them following different paths toward limiting pay increases. ''One group of employers has been using an increasingly adversarial labor strategy,'' says Lewin. Many of these companies $ with a ready supply of replacement prospects, such as Continental Airlines, Greyhound, and the New York Daily News, have been hard-nosed about increases. Others, notably automakers, steelmakers, and supermarket chains, are using a pattern of cooperation and compromise developed over the 1980s -- Lewin calls it a ''portfolio of personnel policies'' -- to contain costs. Take the contract that the United Steelworkers union recently signed with USX. The settlement looks like a bonanza for employees: a first-year increase of $1.50 in hourly pay from a base of $11.21, and another 50 cents in each of the next two years -- plus $3,250 in bonus and cost-of-living payments. Though that barely brings pay scales back to the level of the early 1980s in nominal terms, Audrey Freedman of the Conference Board thinks the agreement is ''too costly to last.'' She expects quiet renegotiations at the plants, yielding concessions that won't be announced from headquarters. Even more important for the overall economy, union contracts with one company no longer set a standard for all other settlements in the industry as they once did. Nevertheless, as the recovery picks up, more employees -- like those steelworkers -- will start to get back some of what they have given up. And companies with expanding business will find it hard to resist raising pay as they try to increase productivity. David Lewin expects employees to start pushing back when employers ask for more. Their cry, he says, will be: ''If you're asking for more work, pay me for it.'' Economists don't disagree as much about the outlook for hourly pay as about how much inflation it implies. Optimists assume that raises will be offset by a spurt in productivity gains. Given the economy's recent performance, the hope seems forlorn. Economic consultant Joel Popkin points out that for each of the six quarters preceding the recession, GNP grew at less than its potential. That gap, partly engineered with monetary policy, was supposed to slow inflation, but it didn't. As Popkin says, ''The Fed forgot the fundamentals. A slow economy begets slow productivity growth and higher unit costs.'' The expansion will be less robust than usual too, which is one reason FORTUNE doesn't expect a sharp turnaround in productivity over the next year or so. Rather than the annual gains of 4% or more that have marked other recoveries, we look for a very modest 1% improvement, compared with no change at all last year and a decline of 1.7% during 1989. Manufacturing companies will continue to outperform the rest of business. The upgrading of equipment and retraining of workers over the past few years has paid off with a productivity gain of 2% during 1989 and a 4.4% rate last year before recession hit. To keep those coming, some companies are looking for help from the outside, especially for temporary employees to handle sudden bulges in work. CORPORATE AMERICA has been suffering mightily from a squeeze on profit margins. As the chart shows, unit profits peaked in 1988 and have been falling ever since. That is a long spell in the pressure cooker for managers, and they will be determined to recoup at least partly as business starts to improve. The gains certainly will not come from lower labor costs. They will not come from lower interest costs either, though these will grow more slowly in the next year than in the past. And in the competitive environment most companies face, don't count on increasing profits by squeezing the advertising and promotion budgets. What's left? You guessed it. The bad or good news, depending on which side you're on, is that competition will also keep managers from raising prices as much as they would like. So after much struggle, margins will retrace only about half the lost ground. The disturbing lack of improvement in inflation, both a cause and result of slow growth, will seem more disturbing still as the 1992 elections come closer. The invasion of Kuwait cheated Federal Reserve Chairman Alan Greenspan out of the ''soft landing'' he was aiming for. And he won't even have slower price increases to ease the pain. Greenspan is likely to resist the Administration's repeated calls for lower interest rates. But he may wait for incontrovertible evidence that the recession is over before he moves in the other direction.

BOX: OVERVIEW

-- Consumer prices will increase more than 5% during the coming year. -- Hourly wages will outpace productivity gains. -- Corporations will partly rebuild profit margins.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: PRESSURE ON PRICES Even hiring temporary workers, like these being tested at Manpower Inc. in Milwaukee, won't hold costs down enough. To improve profit margins, business will raise prices.