U.S. business productivity rose at a 1.1 percent annual rate in the second quarter but unit labor costs jumped sharply, according to a government report that gave the

Federal Reserve a final piece of inflationary data as a pivotal meeting started on Tuesday.

Fed policy-makers are to decide later in the day whether to halt a string of 17 interest rate hikes over 26 months at 5.25 percent.

Financial markets were betting that the chance of a rate hike was just 20 percent as the meeting got under way, but Tuesday's Labor Department data showed that second quarter unit labor costs rose at a 4.2 percent annual pace, their fastest jump since the fourth quarter of 2004, when they rose 5.1 percent.

Wall Street had been looking for a 3.5 percent increase in unit labor costs - a key gauge of profit and price pressures - after a previously reported 1.6 percent rise in the first quarter. The Labor Department revised the first quarter pace upward to 2.5 percent.

With all these price pressures, I can't imagine the Fed sitting still today. The rise in unit labor costs is another in a very long list of hot inflation numbers. That's what the Fed and market should be focusing on. You cannot paint this in a noninflationary way, said Richard Yamarone, chief economist of Argus Research in New York.

U.S. Treasury debt prices extended losses after the unit labor cost rise provided an inflationary sign to investors. Benchmark 10-year notes traded down 3/32 in price for a yield of 4.93 percent.

The second-quarter productivity gain also outpaced the expectations of Wall Street analysts, who forecast a climb of 0.9 percent after a previously reported increase of 3.7 percent in the first quarter. The Labor Department revised the first quarter figure sharply upward, to 4.3 percent.

The productivity number is slightly higher than expected and the unit labor costs (increase) is a big thing, that's up more than expected. Even though we recognize the market is telling us the odds of a Fed rate hike today are slim, we think the market is underestimating those odds and (that's) why we expect the Fed to remain hawkish, said Marc Chandler, chief global currency strategist at Brown Brothers Harriman in New York.

The Labor Department also revised 2005 annual nonfarm unit labor costs downward to a 2.0 percent increase from a previously reported 2.3 percent rise, but this still represented the largest annual increase since 2000.

Hourly nonfarm compensation increased at a 5.4 percent annualized pace in the April-June quarter, compared with a 6.9 percent increase in the first quarter. The first quarter compensation increase was previously reported as a 5.3 percent increase.

But with inflation, workers actually saw little real gain in purchasing power in the second quarter, the Labor Department said.

When the rise in consumer prices is taken to account, real hourly compensation rose 0.4 percent in the second quarter of 2006 after increasing 4.7 percent in the first quarter, the Labor Department said in a statement.

Productivity gains tend to slow as an economic upswing matures and employers struggle to wring additional output from existing workers and equipment, prompting them to hire and invest. This can put upward pressure on labor costs.

In the retail sector, a report from Redbook Research on Tuesday showed that U.S. chain store sales rose in the first week of August, helped by back-to-school tax holidays in some states and summer clearance sales. Sales at major retailers were up 3.2 percent on a year-over-year basis in the week ended August 5, following a 2.8 percent rise the week before.