The Dow Jones fell 205 points immediately after the release of the data, which raised the chances of an interest rate hike as soon as next month. The dollar and government bonds both fell to three-week lows.
Rate worries were heightened by comments by a member of the Federal Reserve Board who said it would be "premature" to rule out a third successive hike.
The fall came within a few ticks of the 210-point level that would have triggered stock exchange trading curbs. The Dow recovered to be down 150 points by midday.
The rise in second-quarter unit labour costs was revised up to 4.5 per cent from 3.8 per cent, much higher than the forecast 4.0 per cent and the steepest rise since the second quarter of 1995.
Productivity of the United States worker, which measures output per hour, rose 0.6 per cent, a downward revision from 1.3 per cent and the smallest since the second quarter of 1998. Economists had expected a figure of 1.1 per cent.
Analysts said that the figures showed that businesses were finding it hard to offset rising labour costs - a major concern of Alan Greenspan, the Federal Reserve chairman. "Given Greenspan's emphasis on productivity as the key to continued prosperity, the numbers look sad," said Scott Brown, an economist at Raymond James in Florida.
But Ian Shepherdson, of High Frequency Economics, said the market had been more unnerved by comments made by Edward Kelly, a member of the Fed's rate-setting committee.
Mr Kelly agreed it was "premature" to rule out another hike and said that the Fed was prepared to act on the crucial non-farm pay roll figure later today showed wages rising.
Mr Shepherdson said: "If these pay roll figures are anything that might be called strong, them rates are going up in October."
Meanwhile US factory orders rose 2.1 per cent in July, the fastest pace this year, boosted by strong demand for durable goods, industrial and electronic equipment.
The gain was the eleventh in the past 14 months and beat forecasts of a 1.8 per cent rise.
The euro pushed to $1.0730, its highest level against the dollar since 10 August. US bonds fell for the fifth day out of six, pushing yields to three-week highs.