Nov. 2 (Bloomberg) -- U.S. labor costs rose as worker productivity unexpectedly stalled in the third quarter, representing a risk to Federal Reserve forecasts that inflation will subside.

Productivity, a measure of how much an employee produces per hour, was unchanged after a 1.2 percent gain in the second quarter that was weaker than previously estimated, the Labor Department said today in Washington. Labor costs rose at a 3.8 percent pace and were up 5.3 percent in the 12 months though September, the biggest gain since 1982.

Coming a day before the October unemployment report, the figures may not be welcomed by Fed policy makers, who last week said inflation is ``likely to moderate over time.'' Smaller gains in efficiency and rising labor costs may prompt companies to raise prices to protect profits, casting doubt on the central bank's view.

``Five percent annual unit labor cost growth is really concerning and has always been consistent with an upturn in inflation,'' Tim Rogers, chief economist at Briefing.com in Boston, said before the report.

Labor expenses represent about two-thirds of the cost of producing a good or service, and an acceleration would offset some of the recent declines in raw-material prices.

The number of Americans filing first-time claims for unemployment benefits jumped to a three-month high last week, a sign the labor market may be weakening, the Labor Department said separately. Initial jobless claims rose 18,000 to 327,000, the highest since early July, from a revised 309,000 the week before.

Forecast 1% Gain

Economists expected productivity to rise at 1 percent annual rate for the third quarter, according to the median of 60 forecasts in a Bloomberg News survey. Unit labor costs were projected to rise at a 3.4 percent pace.

Compensation for each hour worked rose to an annual rate of 3.7 percent in the third quarter, compared with a 6.6 percent increase the prior quarter.

Productivity stalled because a 1.6 percent gain in hours worked at an annual pace equaled the increase in economic growth.

Among manufacturers, productivity rose at a 5.9 percent pace after rising 2.7 percent in the second quarter. Productivity at non-financial corporations, a measure watched by the Federal Reserve, rose at a 0.2 percent rate in the second quarter. Those figures are released with a one-quarter lag.

A report yesterday showed inflationary pressures are easing. The Institute for Supply Management's measure of prices paid by manufacturers dropped to the lowest level in more than four years last month, the group said. Crude oil futures prices have dropped 25 percent on the New York Mercantile Exchange since touching a record $78.40 a barrel on July 14.

`Some Inflation Risks Remain'

Fed policy makers last week held their target for the interest rate on overnight loans between banks at 5.25 percent for a third month. In announcing the decision, they said that while ``some inflation risks remain,'' a slowing economy will probably cause inflation to moderate.

In the minutes of their September meeting, the central bankers said that still-high commodity prices, low unemployment and rising labor costs were among the things that raised the risk that inflation wouldn't slow as expected.

``Unit labor costs are going to continue to be a preoccupation for monetary policy makers,'' Richard DeKaser, chief economist at National City Corp. in Cleveland, Ohio, said before the report. Concern about these costs will keep the Fed from changing its policy direction any time soon, he said.

Prior to both the August and September meetings, Fed economists reduced their estimate of how fast the economy can grow without fueling inflation, according to the minutes of the gatherings. A deeper-than-expected slowdown in productivity was one reason for the estimates were cut.

Raising Prices

Some companies are having to resort to raising prices as labor costs climb. Sonoco Products Co., which makes boxes, food cans and industrial packaging, said last month that third-quarter profit rose 33 percent as prices increased faster than raw- material costs.

The profit increase ``reflected a continued favorable selling price/material cost relationship and the impact of productivity improvements, which were partially offset by higher energy, freight and labor costs,'' said Harris Deloach Jr., Sonoco's chief executive officer in an Oct. 18 statement.

Deloach said last month he will shut 12 plants and eliminate 540 jobs, or 3.1 percent of the workforce, to improve productivity and trim expenses.

The Labor Department last month provided more evidence that efficiency may be slowing even more than currently thought. The government said Oct. 6 that about 810,000 more jobs were created in the 12 months though March than estimated before.

Assuming no upward revisions to growth, that suggests it took more workers to produce the same amount of goods, meaning productivity may be weaker and labor costs are even higher than currently thought, Ellen Zentner, an economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York, said before the report.

Economists surveyed by Bloomberg expect the Labor Department to report tomorrow that the economy created 120,000 last month, rebounding from a 51,000 gain in September that was the weakest in a year, according to the median estimate of economists surveyed by Bloomberg News. Hiring would still fall short of this year's 137,000 monthly average.

To contact the reporter on this story: Courtney Schlisserman in Washington at cschlisserma@bloomberg.net.

Last Updated: November 2, 2006 08:30 EST