By Lucia Mutikani
WASHINGTON (Reuters) - A plunge in the productivity of businesses late last year will probably dent corporate profits, but not enough to prompt companies to cut back on hiring.
Nonfarm productivity, which measures hourly output per worker, fell at its fastest pace in four years in the fourth quarter, the government reported last week.
The drop led unit labor costs - the cost of labor for any given unit of production - to surge 4.6 percent, a sign of increased profit pressures.
But there are no signs yet that a profit squeeze has stalled hiring or fueled a pick-up in lay-offs, and many economists say that is unlikely to happen with pay gains still modest.
"The recent slowing in productivity growth will likely lead to, at most, only a modest narrowing of corporate profit margins," said Michael Feroli, an economist at JPMorgan in New York. "Nominal hourly pay gains are advancing at a rate just under 2 percent, about the same rate as the increase in the prices at which businesses sell their products."
The 1.9 percent drop in productivity in the fourth quarter was tied to a sharp weakening in economic growth, which was caused by temporary factors such as a slowdown in the pace of inventory accumulation and deep cuts in defense spending. So, a snap back is in order, which should help shield profits.
While analysts have cut their first-quarter earnings growth forecasts for Standard & Poor's 500 companies, the main concern has been the weakness of consumer spending. According to the latest Thomson Reuters data, the consensus is for growth of 1.5 percent, down from 4.3 percent on January 1.
For the whole of 2013, however, corporate earnings growth is forecast at 9.2 percent, down from the 10.9 percent rate seen on January 1.
"More productivity growth would be nice, but even without it business profit margins appear to be under little threat for the time being," said Feroli, noting that material inputs were the largest cost for many firms.
Indeed, the latest signals on the pace of lay-offs appears to support this view.
First-time applications for state unemployment benefits have dropped from a high of 451,000 in November last year to around 340,000 in early March - a level considered normal.
That was corroborated by government data on Tuesday showing that lay-offs in January were the lowest since 2000. The slower pace of lay-offs has given a lift to net growth in nonfarm payrolls, even as hiring has remained sluggish.
SUBDUED LAY-OFFS TO THE RESCUE
"Normally, declining productivity means a pull-back in hiring, but because lay-offs have subsided, that's not going to be the case," said Jacob Oubina, senior U.S. economist at RBC Capital Markets in New York.
"The productivity and earnings picture tells you that the hiring side will remain pretty flat. But if you see claims (for unemployment benefits) suddenly start to look worse, then that will start to eat away at your net non-farm payrolls number."
Patrick O'Keefe, head of research at CohnReznick in Roseland, New Jersey, argues that employers have been so cautious in bringing on staff that they do not have to let workers go when demand softens.
O'Keefe is among a group of economists who argue that the slowdown in productivity may actually be a signal that employers have extracted as much as they can from their current employees.
"To some extent it may signal that there is a need to increase hiring," he said.
Private sector employers have added an average of 200,000 workers to their payrolls in the six months through February, with hiring in the construction sector picking up speed.
O'Keefe said that could help raise productivity given how lean construction firms are and how strong demand is.
However, not everyone agrees companies will be able to maintain their current pace of hiring if productivity does not pick up.
"It suggests that earnings-driven companies have already reached their earnings and payroll limits. You need to get top line revenue growth going and that doesn't seem to be happening," said Steven Ricchiuto, chief economist at Mizuho Securities in New York.
He expects employment growth to slow in the second quarter.
"I don't see how you would continue to hire people when it is squeezing your profitability."
(Additional reporting by Caroline Valetkevitch; Editing by Dan Grebler)