(Reuters) -Home Depot Inc forecast annual profit below Wall Street expectations on Tuesday as demand for home improvement products dwindle due to soaring inflation, while it grapples with higher costs and a tighter labor market.

The No. 1 U.S. home improvement chain posted a surprise drop in fourth-quarter comparable sales, sending its shares down more than 4% in premarket trading.

Shares of smaller rival Lowe’s Cos Inc also slipped after Home Depot’s dour forecast amid a strained U.S. housing market.

Following an exponential surge in remodeling activity during the pandemic, demand for home improvement tools such as paint and flooring is now cooling as consumers cut back spending.

Wall Street analysts have warned that home improvement chains are set for a challenging 2023.

Contractor sales soured in December from a month earlier, Wells Fargo analysts have said. A survey by the brokerage showed about 40% of contractors said backlogs were getting weaker heading into the year.

Home Depot said comparable sales fell 0.3% in the fourth quarter ended Jan. 29, compared with analysts’ average estimate of a 0.56% increase. Customer transactions fell 6% in the quarter.

The company said it expects earnings per share to decline in the mid-single digits percentage range for 2023, while analysts were expecting a 0.4% increase to $16.72, according to Refinitiv data.

Home Depot is seeing elevated costs across its supply chain despite taking cost control measures, while a tight U.S. labor market has prompted it to invest more in employee wages and benefits.

Home Depot said it would spend an additional $1 billion in annualized compensation for its frontline, hourly associates, starting from the first quarter of 2023.

It also projected 2023 sales growth to be flat compared to fiscal 2022.

(Reporting by Deborah Sophia in Bengaluru; Editing by Arun Koyyur)