Productivity surge signals job growth to follow

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By Lucia Mutikani

WASHINGTON (Reuters) - U.S. business productivity grew at its fastest clip in six years in the third quarter and new claims for jobless aid fell to a 10-month low last week, suggesting the labor market may be starting to bottom out.

The Labor Department said on Thursday that productivity surged at a 9.5 percent annual rate, the quickest pace since the third quarter of 2003, as companies squeezed more output from a smaller pool of labor to hold the line on costs.

The Labor Department also reported that initial claims for state unemployment benefits dropped to 512,000 in the week ended October 31, the lowest level since early January. Markets had expected a decline to only 523,000, from the 530,000 reported in the prior week.

Some healing of the labor market is crucial to sustaining and strengthening the economy's recovery after its worst recession in 70 years, with employment key to underpinning consumer spending.

Analysts doubt that the rapid growth rate in productivity, which measures the hourly output per worker, can be sustained, which some analysts say means businesses may soon have to step up hiring to meet the demand for their goods and services.

"We expect the pace of efficiency gains will soon begin to fade," said Michelle Girard, a senior economist at RBS in Greenwich, Connecticut. "Having cut payrolls so dramatically during the last downturn, we believe that companies will be forced to add workers earlier in this recovery than was the case following the last two recessions."

U.S. stocks rallied on the data, driving up the three main indexes more than 1 percent higher in morning trade.

Financial markets had expected productivity to rise at a 6.4 percent rate. It grew at a 6.9 percent pace in the April-June period, when the economy was still contracting.

MUTED INFLATION PRESSURES

The U.S. Federal Reserve on Wednesday held overnight interest rates close to zero percent and said it would keep them extraordinarily low as long as excess economic slack and a lack of inflation warning signs prevailed.

The U.S. economy grew in the third quarter for the first time in more than a year, driven largely by government stimulus.

The strong productivity report suggested little need to worry about inflation at this juncture.

Unit labor costs, a measure of the cost of labor for any given amount of production, fell 5.2 percent last quarter after declining 6.1 percent the previous period. Analysts had forecast a drop of only 4 percent.

"Heightened productivity, the shrinkage of unit labor costs improves prospects for hiring over the near term. It points toward wider profit margins, faster earnings growth and more hiring activity," said John Lonski, chief economist at Moody's Investors Service in New York.

Productivity in manufacturing rose at a record 13.6 percent rate in the third quarter, likely driven by automakers ramping up production to rebuild depleted stocks after the popular "cash for clunkers" program boosted sales.

Compensation per hour jumped at a 3.8 percent pace, but after adjustment for inflation it was up only 0.2 percent -- pointing to sluggish growth in incomes.

In the weekly jobs claims report, the four-week moving average for new benefit claims slipped 3,000 to 523,750 last week, the lowest in almost 10 months. The average, which is seen as a better gauge of underlying trends, has declined for nine straight weeks.

Still, claims remain high. Analysts say they need to drop below 400,000 to signal that the economy is creating jobs.

U.S. employers have cut 7.2 million workers from their payrolls since the economy fell into recession in December 2007, but the pace of job cuts has been easing.

While the Labor Department is expected to report on Friday that the decline in employment slowed further in October, the jobless rate is expected to rise to 9.9 percent, up from a 26-year high of 9.8 percent in September.

There were further hints of labor market improvement in the data on Thursday. The number of people still on the jobless benefit rolls after collecting an initial week of aid dropped to the lowest level since March in the week ended October 24, the latest week for which data was available.

"The falling number of people on state unemployment insurance programs implies that the unemployment rate is probably approaching its peak. We look for the unemployment rate to peak around 10.2 percent in early 2010," said Abiel Reinhart, an economist at JP Morgan in New York.

(Editing by Leslie Adler)

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