The economy may be stumbling, but U.S. labor productivity was stronger than expected in the third quarter, rising 2.7% on an annualized basis. This is up from 2.2% in the previous quarter.

Economists say, however, the increase resulted from working hours dropping faster than output.

Yesterday in cutting rates, the Fed said that productivity will likely take a hit in the short-term as firms invest in unproductive things like security. But, BMO Nesbitt Burns notes, “The terrorist attacks had little impact on productivity, aside from a slight adjustment to hours worked. Instead, firms were slashing payrolls in response to the slowing economy. Unit labor costs were quite constrained, rising by 1.8%.”

The manufacturing sector saw a 1.1% rise in productivity, as its output fell by 6.7% and hours worked fell by 7.7%. “This was the fourth straight quarterly decline in factory hours, and the most severe fall in the current downturn,” says BMO.

BMO says that the new security priority may reinforce an existing downtrend in business spending, but it does not change the view that the second half of next year will see business investment begin to recover.

“The productivity gains have occurred as firms have cut labour severely in response to dropping output. With firms also having little to no pricing power, and labour costs well under control, there is no upward pressure on inflation. Thus, the Fed has the flexibility to do whatever it feels is necessary.”