(Bloomberg) -- US corporate profits declined in the fourth quarter and a key gauge of economic activity stumbled as companies battled rising costs and softer demand against a backdrop of higher borrowing costs.

Adjusted pretax corporate profits fell 2% in the final three months of 2022, the most in two years, according to Commerce Department figures published Thursday. Profits retreated at both domestic non-financial and financial corporations. From a year earlier, profits were up 2.6%.

The government’s two main measures of economic activity diverged in the fourth quarter. A gauge of the income generated and costs incurred from producing goods and services — gross domestic income — decreased 1.1% after rising at a 2.8% pace in the third quarter. The decline in GDI was the largest since the start of the pandemic.

Gross domestic product, the more widely cited measure, rose 2.6% in the fourth quarter, little changed from the government’s previous estimate. The average of GDP and GDI showed a 0.7% increase, compared to 3% in the prior quarter. The group that officially determines the timing of business cycles watches the average closely.

One of the Federal Reserve’s preferred inflation metrics, the personal consumption expenditures price index minus food and energy, was revised up to 4.4% from a previous estimate of 4.3%.

Many companies have aggressively raised prices over the past year in an effort to pass on higher costs for labor and materials. At the same time, persistent price hikes by companies risk causing an economy-wide pullback in demand.

So far, a strong labor market — marked by low unemployment and rising wages — has given consumers the wherewithal to keep spending, even though rising labor costs without firmer productivity growth continue to put pressure on profit margins.   

A measure of US profit margins continued to ease. After-tax profits as a share of gross value added for non-financial corporations, a measure of aggregate profit margins, fell in the fourth quarter to 13.9% from 14.9% in the prior quarter.

While margins remain high, they are shrinking, something that could ultimately lead not only to a retrenchment in business investment but also layoffs. 

For all of last year, profits in the financial sector dropped $52 billion, while profits climbed more than $192 billion at non-financial firms.

The picture has darkened in recent weeks. After a surge of spending and a pickup in inflation early in the year sparked discussion of a re-acceleration in the economy, the collapse of four banks has now heightened concerns of recession.

The failure of Silicon Valley Bank earlier this month exposed vulnerabilities in the company’s balance sheet amid rapidly rising interest rates. Looking ahead, already tight credit conditions are expected to become even more restrictive, raising the hurdle for households and businesses to borrow.

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