Update: Economy Lost Jobs in July; Unemployment Rate Steady at 4%

Updated from 9:48 a.m. EDT

The U.S. workforce contracted in July for the first time in more than four years, in large part because government census workers were laid off.

But even excluding census workers, jobs growth in most sectors slowed in July, suggesting that the labor market, a linchpin of the nation's economic prosperity, might be cooling in response to higher interest rates.

Nonfarm payrolls, a broad measure of job creation in the U.S., declined by 108,000 after rising by a revised 30,000 in June, the Labor Department said Friday.

It was the first time that payrolls have shrunk since January 1996, when winter weather caused a 69,000 decline, and the biggest drop in payrolls since April 1991, when the country was mired in recession.

The data include 290,000 layoffs of temporary census workers who had been hired earlier in the year, leading to an overall 246,000 decline in government workers. Excluding government payrolls, jobs grew 138,000, slower than the 242,000 non-government jobs created in June.

The decline in payrolls contrasted with the expectations of economists surveyed by Reuters, who had expected the addition of 58,000 jobs.

Despite the overall shrinking of payrolls, the unemployment rate was steady at 4%.

The data, which suggest that job growth is slowing, could convince Federal Reserve policymakers to leave interest rates unchanged when they meet on Aug. 22. In recent testimony before Congress, Alan Greenspan, the Fed's chairman, said the Fed's coming decision on interest rates would largely depend on the strength of such economic data as the jobs report.

"With this kind of reading, it seems that the Fed has accomplished what it set out to do," said Paul Kasriel, chief economist at Northern Trust. "Growth seems to be slowing, given the lower levels of consumer purchases, reduced rate of home sales and slower jobs growth."

The Fed has raised short-term interest rates six times since June 1999 in an attempt to slow the economy and reduce the risk of inflation by making it more costly for businesses and consumers to borrow and spend. As labor markets tightened in recent years, the Fed has repeatedly warned that the shrinking pool of available workers could cause wages to rise, leading to broader inflation as companies keep up with worker costs.

At its most recent meeting in June, however, the Fed left rates unchanged, citing slower growth for portions of the economy.

Fred Breimeyer, chief economist at State Street Advisors, said the report offered further evidence that the economy has stabilized from the frantic pace of recent years.

"It suggests the economy is performing reasonably well, but not as dynamic as before," he said. "There's nothing dire in it. It's an absence of bad news, if you will," he added, noting that the numbers don't portend further rate hikes in the near term. "On balance, this report probably tilts to the fed doing nothing in August," he said.

Inflationary pressures in the jobs market also remained mostly subdued in July. Workers' wages kept growing, but did not accelerate, as average hourly earnings rose 0.4% for the second straight month, bringing the average hourly wage to $13.76 in July, vs. $13.70 in June.

On an annual basis, wage growth was up 3.7% vs. 3.6% in June. However, economists say that wage growth remains benign in light of recent gains seen in the hourly output of the average worker, known as productivity.

"Wage growth at these levels is being kept in check by rising productivity," said Kasriel. "And we don't expect productivity to stop growing because there is so much high-tech manufacturing activity. Companies are making products and technologies that are going to drive productivity even higher in years to come."

Despite the overall slowdown in jobs growth, hiring remained strong in several sectors. Manufacturing payrolls rose 46,000 in July following a 13,000 increase in June. Construction jobs increased by 6,000 after a 2,000 rise in June. Financial firms' payrolls rose 6,000 in July, the first increase in that sector since February.

Retail jobs also increased, by a solid 49,000 vs. a 48,000 rise in June, driven by heavy hiring in eating and drinking establishments. But overall service-sector payrolls declined by 161,000 following a 15,000 gain in June.

Government payrolls saw a net 246,000 decrease following a 212,000 drop in June. Government payrolls had growth of 345,000 and 336,000 in May and April, respectively, as the government had stepped up census hiring efforts.