Feb. 6 (Bloomberg) -- Worker productivity in the U.S. grew more than forecast in the fourth quarter as companies held down labor costs, a sign that inflation pressures may recede.

Productivity, a measure of employee efficiency, rose an annualized 1.8 percent, after a 6 percent pace in the third quarter, the Labor Department said today in Washington. The report also showed that businesses cut employees' hours at the fastest pace in almost five years in an effort to control expenses as the economy hovers on the verge of the first recession since 2001.

The figures may ease Federal Reserve concerns that the most aggressive interest-rate cuts since 1990 will spur inflation. Richmond Fed President Jeffrey Lacker, who alone voted for higher borrowing costs in late 2006, told students at Marshall University in Huntington, West Virginia, today that further cuts may be warranted.

``This gives the Fed more flexibility to respond to weakness in growth,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. ``It certainly looks like there is more easing to come.''

The median forecast in a Bloomberg News survey was for a 0.5 percent gain. Labor costs rose less than forecast, the figures showed.

Treasury notes, which had fallen earlier in the day, stayed lower after the report. Ten-year yields advanced to 3.60 percent at 3:25 p.m. in New York from 3.57 percent late yesterday.

Labor Costs

Unit labor costs, which are adjusted for gains in efficiency, rose 2.1 percent after dropping 1.9 percent in the prior three months. Economists in the Bloomberg survey had projected a 3.5 percent increase. Compensation for each hour worked increased at an annual rate of 3.9 percent, compared with a 4 percent gain the prior quarter.

Hours worked dropped at a 1.5 percent pace, a second consecutive decline and the biggest since the first three months of 2003.

The drop in employee hours is a ``negative omen for the labor market,'' Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York, wrote in a note to clients. ``The productivity data further justify the Fed's bias toward downside risks to growth.''

Consumer prices, excluding food and fuel, rose 2.4 percent in December from a year ago. Overall expenses climbed 4.1 percent.

GM, Ford Cuts

U.S. automakers are taking steps to increase efficiency and end losses. General Motors Corp., the world's largest, said last quarter it would eliminate a shift with 1,000 workers at a Michigan plant because the factory can produce enough of its sport-utility vehicles with fewer employees.

GM and Ford Motor Co. already cut about 68,000 workers since 2005 under buyout programs designed to increase the productivity of their plants, and Chrysler said last year that it wants to trim 25,100 workers. GM and Ford will also offer new buyouts this year to get additional workers to leave.

Traders anticipate Fed policy makers will cut their benchmark rate by half a point at or before the March 18 meeting, futures contracts show. Chairman Ben S. Bernanke and his colleagues have lowered the rate to 3 percent from 5.25 percent since September.

Broad Trend

For all of last year, productivity picked up to a 1.6 percent pace, from a 1 percent rate the previous year. Still, efficiency gains have slowed since a jump that began in the late 1990s with the spread of the Internet and surge in equipment and software investment. Annual productivity advanced less than 2 percent the past three years, the worst record since 1995.

Labor costs rose 3.1 percent last year, the most since 2000.

Productivity at non-financial corporations, a measure watched by former Fed Chairman Alan Greenspan, rose at a 3.7 percent rate in the third quarter after rising 2.1 percent in the prior three months. The figures are released with a one-quarter lag.

Among manufacturers, productivity increased at a 2.5 percent pace last quarter, following a 4 percent gain.

Productivity gains may be harder to come by as the economy weakens because businesses are usually slow to reduce staff, economists said.

Economic growth slowed to an annual rate of 0.6 percent in October through December, down from a 4.9 percent pace in the third quarter, according to government figures last week. A report from the Institute for Supply Management yesterday showed service industries unexpectedly contracted in January at the fastest pace since the 2001 recession.

Payroll Changes

Still, some businesses have already reacted to the demand slowdown. Companies added 1,000 workers to payrolls in January, while government agencies reduced staff. The economy lost 17,000 jobs overall, the first decline in more than four years. Hourly wages rose 0.2 percent last month, less than economists had forecast.

Labor expenses account for about two-thirds of the cost of producing a good or service.

In the late 1990s, Greenspan was one of the first to recognize that productivity was accelerating, and that the improvement could help contain inflation even as the economy strengthened and unemployment stayed low. The realization allowed the Fed to keep rates little changed from 1996 to 1999.

Higher raw-materials expenses are pushing companies to wring out more productivity. General Mills Inc., the second-largest U.S. cereal maker, is reducing the effect of rising wheat and dairy prices by cutting costs and boosting efficiency, Chief Executive Officer Kendall J. Powell said last month.

``The first line of defense for us is productivity,'' Powell said in a Bloomberg Television interview on Jan. 23 from the World Economic Forum in Davos, Switzerland.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net.

Last Updated: February 6, 2008 15:30 EST