| NEW YORK
NEW YORK The dominant U.S. service sector improved last month and businesses boosted productivity in the second quarter but evidence of labor market weakness overshadowed other data the day before a key jobs report.
The Labor Department said on Thursday that business productivity surged at a revised 4.3 percent annual rate, nearly double the 2.2 percent gain previously reported and well ahead of forecasts for a 3.5 percent increase.
"We're not in an ugly environment but we're not in a great environment either," said Kurt Brunner, portfolio manager at Swarthmore Group in Philadelphia.
Companies have cut payrolls in each of the first seven months this year and an intently awaited report on Friday is expected to show that they did so again in August.
A separate report from the Labor Department confirmed a steadily weakening labor market as the number of U.S. workers filing new claims for jobless benefits jumped by 15,000 last week to a seasonally adjusted 444,000.
That was much higher than the 425,000 claims that analysts surveyed by Reuters had anticipated and helped send major U.S. stock indexes down more than 2 percent. But prices for U.S. Treasury debt extended gains as investors bet the Federal Reserve would keep interest rates low.
Another report from ADP Employer Services showed private employers cut 33,000 jobs in August, which some analysts said increased chances that Friday's payroll report from the Labor Department will be weak.
The Institute for Supply Management said its non-manufacturing index rose to 50.6 for August from July's 49.5, with a reading above 50 signaling expansion. The ISM report showed inflation pressures in the service sector moderated but the jobs picture also deteriorated.
The report on productivity, which is a gauge of hourly output per worker, showed companies keeping a tight grip on costs by keeping their payrolls lean.
Unit labor costs, a gauge of inflation and profit pressures closely watched by the Federal Reserve, decreased 0.5 percent in the second quarter.
Generally, analysts said the higher productivity was encouraging, since it keeps inflation in check and could help support business profits at a time of soaring costs, though it did reflect tough economic conditions.
"We don't have worry about a wage spiral but we do have worry about consumer purchasing power," said economist Christopher Low of FTN Financial in New York. "Given the credit conditions, spending power is going to be a real problem the rest of this year and into next year."
The latest figures from the retail sector illustrated the dire straits of many consumers, who confronted job losses even as food and energy prices surged this year.
U.S. discounters, led by Wal-Mart Stores Inc (WMT.N), remained a bright spot in a weak retail industry in August, as shoppers sought back-to-school deals, while department stores and luxury chains disappointed.
"Consumers are very focused on value, stretching their dollars; and anything deemed not absolutely of need, they are forgoing those purchases," said Ken Perkins, president of Retail Metrics.
In contrast to the strong gain in overall business productivity, the manufacturing sector skidded lower in the second quarter. The decline was concentrated in production of durables goods, including the struggling automobile sector.
Manufacturing productivity plunged 2.2 percent during the second quarter -- the biggest quarterly drop in 19 years -- after increasing 3.3 percent in the first quarter.
Output by manufacturers fell 3.7 percent, its steepest fall since the final quarter of 2001 after terror attacks led to a steep pullback in production.
Similarly, the ADP report on private sector employment reflected the difficulties in the manufacturing sector, where job cuts outweighed hiring in services.
Also, overall employment in the goods-producing sector -- which includes manufacturing, construction and mining -- marked 21 consecutive months of decline in August. This appears consistent with an economy that has been hit by a major decline in home construction and related businesses.
Analysts said the U.S. unemployment rate probably will keep moving higher as a sluggish economy encourages companies to lay off rather than to hire.
"Given the steady upward march in continuing claims and further losses across the broad spectrum of the economy, we expect the rate of unemployment to rise to 5.8 percent in August and move towards 6.2 percent early in 2009," said Joseph Brusuelas, chief economist for Merk Investments in Palo Alto, Calif.
(Additional Reporting by Glenn Somerville in Washington, Kristina Cooke in New York, Editing by Chizu Nomiyama)