May 7 (Bloomberg) -- U.S. worker productivity unexpectedly accelerated in the first quarter as cuts in jobs and hours left fewer employees to do more, helping combat inflation.

Productivity, a measure of efficiency, rose at a 2.2 percent annual rate after a 1.8 percent gain the fourth quarter, the Labor Department said today in Washington. Labor costs climbed at a 2.2 percent pace, down from a 2.8 percent increase in the last three months of 2007.

Slowing sales and soaring expenses for raw materials like fuel prompted companies to trim staff hours by the most in five years last quarter. The weakening job market will probably keep a lid on increases in pay, indicating there is little risk that escalating wages will boost inflation.

``Because of the downturn in the economy, firms are relying more on productivity than increased labor for output,'' said Jonathan Basile, an economist at Credit Suisse Holdings Inc. in New York. ``This is constructive for the inflation picture.''

After the report, U.S. stocks were little changed and the dollar stayed higher against the euro. The dollar increased 0.8 percent to $1.5403 against the euro at 9:31 a.m. in New York, from $1.5533 yesterday, and the Standard & Poor's 500 Index opened down 1 to 1,417.3.

Economists forecast productivity would rise at a 1.5 percent annual pace, according to the median of 69 projections in a Bloomberg News survey. Estimates ranged from gains of 0.5 percent to 2.5 percent.

Slowing Growth

Unit labor costs, which are adjusted for the changes in efficiency, were forecast to rise 2.6 percent, according to the Bloomberg News survey. Estimates ranged from gains of 1.5 percent to 4.5 percent.

Productivity measures how much an employee produces for each hour of work. Generally, as the economy slows, companies pull back production, hiring and other spending to try to boost efficiency and lower costs.

The U.S. economy expanded at a 0.6 percent annual pace the first three months of this year. Over the past two quarters, the pace of growth has been the weakest since the final six months of 2001, when the economy was in a recession.

Hours worked dropped at a 1.8 percent pace, the most since the first quarter of 2003, today's report showed.

U.S. employers cut payrolls in each of the last four months, bringing the total number of jobs lost this year to 260,000.

Compared with the same period last year, productivity rose 3.2 percent, the biggest gain in almost four years.

Labor Costs

Unit labor costs, which reflect the gain in efficiency, were up 0.2 percent compared with a year earlier, the least since the second quarter of 2004.

Compensation for each hour worked increased at an annual rate of 4.4 percent in the first quarter, compared with 4.6 percent the final three months of 2007, today's report showed.

Adjusted for inflation, hourly pay decreased 0.7 percent in the year ended in March, the weakest performance in almost 13 years. That is one reason economists are forecasting consumer spending, which accounts for more than two-thirds of the economy, will slow in coming months.

A Labor Department report last week signaled the slowing job market is subduing wages. Average hourly earnings rose 0.1 percent in April, the least in six months, the government said.

Smaller increases in wages, which account for about two- thirds of the cost of producing a good or a service, would reduce inflationary pressures. Some Federal Reserve policy makers have said they are concerned increases in food and fuel costs will boost other prices.

Fed Rate Cuts

The central bank's Federal Open Market Committee on April 30 lowered the target for the overnight lending rate between banks by a quarter point, to 2 percent. In the text accompanying its announcement, the Fed said uncertainty about prices ``remains high'' though it projects inflation will ``moderate in coming quarters.''

Productivity at non-financial corporations, a measure watched by former Fed Chairman Alan Greenspan and other policy makers, increased at a 1.8 percent rate in the fourth quarter. These figures are released with a one-quarter lag.

In the late 1990s, Greenspan was one of the first to recognize that the increased use of computers and the Internet were helping to boost productivity, and that the improvement could help contain inflation even as the economy strengthened and unemployment remained low. The realization allowed the Fed to keep interest rates little changed from 1996 to 1999.

``As long as corporate profit margins can be somewhat sustained or at least cushioned by the increase in productivity that is a good sign,'' Russell Price, senior economist at H&R Block Financial Advisors Ltd. in Detroit, said in an interview with Bloomberg Television.

Productivity, Profits

Electronic Data Systems Corp., the world's second-biggest computer-services provider, last month reported first-quarter profit that beat estimates as contract signings soared 66 percent. Productivity improvements, such as reducing facilities that store client data, helped lift earnings by 2 cents a share.

Chief Executive Officer Ronald Rittenmeyer is firing workers and moving jobs to lower-cost labor markets such as India to reduce spending and attract more clients with lower prices. While a slowing U.S. economy has forced some clients to reduce spending on small projects, especially in the manufacturing and consumer-products industries, other customers are spending more, Rittenmeyer said.

``It's slower, and I think we've seen some projects just take a little bit longer to get booked out,'' he told analysts on an April 24 conference call. ``We haven't felt as much pressure as I was worried about.''

Among manufacturers, productivity rose at a 4.1 percent pace from January through March following a 4.2 percent gain in the fourth quarter.

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

Last Updated: May 7, 2008 09:38 EDT