Nov. 5 (Bloomberg) -- Worker productivity surged at the fastest pace in six years, labor costs fell and unemployment claims were lower than forecast, signaling companies may be preparing to start hiring again after cutting costs to the bone.

Productivity, a measure of employee output per hour, jumped at a 9.5 percent annual rate in the third quarter, exceeding the highest economist forecast, according to Labor Department figures released today in Washington. Initial jobless claims dropped by 20,000 to 512,000 in the week ended Oct. 31, the fewest since January.

Stocks climbed on signs the economic recovery is gaining strength while generating little inflation pressure, ratifying the Federal Reserve’s decision yesterday to keep interest rates near zero for an “extended period.” A report tomorrow may show that employers cut jobs at the slowest pace in more than a year as they begin to anticipate sales gains.

The jump in productivity “tells the Fed it can be on hold for quite some time,” said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York, whose forecast was the highest among economists surveyed. “Business investment spending and employment will be pushed higher in the next few months.”

The Standard & Poor’s 500 Index rose for a fourth day, gaining 1.9 percent to 1,066.63 at 4:07 p.m. in New York. The Dow Jones Industrial Average jumped 2.1 percent to 10,005.96, closing above 10,000 for the first time since Oct. 22.

Economists had projected productivity would rise at a 6.5 percent annual pace, according to the median of 70 forecasts in a Bloomberg News survey. Estimates ranged from gains of 3.8 percent to 8.5 percent.

Unemployment claims were forecast to fall to 522,000 from an originally reported 530,000 a week earlier, according to the median of 42 estimates in a Bloomberg survey.

Labor Costs

Labor costs fell at a 5.2 percent rate, capping the biggest 12-month drop since records began in 1948 and exceeding the median forecast for a 4.2 percent decline projected by economists. Costs in the prior quarter fell 6.1 percent, more than previously estimated.

Gains in productivity are boosting company earnings. For the July to September quarter, profits exceeded the consensus estimate of analysts for 81 percent of S&P 500 companies that have reported so far, data compiled by Bloomberg show.

Johnson & Johnson, the world’s largest health-products company, said this week it plans to fire more than 7,000 workers. While the majority of cuts will occur outside the U.S., the New Brunswick, New Jersey-based company said within the country they’ll be across all businesses.

“People just aren’t spending as much as they used to,” Chief Executive Officer Bill Weldon said in a telephone interview on Nov. 3.

Back-to-Back Gains

The third-quarter jump in productivity followed a revised 6.9 percent increase in the prior three months, marking the biggest back-to-back gain in productivity since 1961.

“This should be a healthy development for corporate profits, but it also tells us that the economy cannot grow on productivity gains alone,” Joseph LaVorgna, chief economist at Deutsche Bank Securities Inc. in New York, said in a note to clients. “Hours worked must also rise, either through a longer workweek or increased hiring.”

The productivity report showed hours worked declined at a 5 percent pace, while output climbed at a 4 percent rate. Compensation for each hour worked rose at a 3.8 percent annual pace, up from a 0.3 percent rate the prior quarter.

The year-over-year measure of hours worked dropped at the fastest pace since data began six decades ago, while the 12- month increase in hourly compensation at 0.5 percent was also the smallest on record.

Fed Statement

Fed policy makers yesterday signaled a return to economic growth alone won’t warrant higher interest rates, saying an increase will instead depend on when the labor market and inflation pick up.

The central bank’s rate-setting Federal Open Market Committee said for the first time that its commitment to low borrowing costs depends on “low rates of resource utilization, subdued inflation trends and stable inflation expectations.”

The economy grew last quarter for the first time in more than a year, even as employers cut 768,000 workers from payrolls, indicating those Americans who still had jobs were more efficient. The third quarter’s 3.5 percent rate of expansion was the strongest in two years.

Government stimulus measures such as the homebuyer tax credit are boosting consumer demand, helping to pull the economy out of its worst recession in seven decades.

Tax-Credit Extension

The U.S. Senate yesterday approved a $45 billion plan to expand a tax credit for first-time homebuyers, extend jobless benefits and provide tax refunds to money-losing companies. Lawmakers voted 98-0 for the measure, sending it to the House, where Majority Leader Steny Hoyer of Maryland said in a statement it will receive a vote as early as today.

A Labor Department report tomorrow may show that payrolls fell by 175,000 in October, the smallest decline since August 2008, according to the median forecast in a Bloomberg survey of 84 economists. The unemployment rate probably rose to 9.9 percent from 9.8 percent.

The economy has lost 7.2 million jobs since the recession began in December 2007.

To contact the reporters on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net; Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: November 5, 2009 16:36 EST