Update: Jobs Growth Not as Slow as It Looks, but Slow Enough to Please Fed

Updated from 10:24 a.m. EDT

The slowdown continues, further dousing the possibility of additional interest rate increases by the Federal Reserve .

To be sure, the headline number out of the August employment report (definition | chart | source ) -- a drop in nonfarm payrolls of 105,000 -- greatly overstates the case.

"This is not a job loss story," said Fred Breimyer, chief economist at State Street Advisors. The 105,000 lost jobs "says nothing about the underlying condition of the economy."

That drop is the largest since April 1991, when the economy was emerging from the last recession. But it's largely irrelevant. The Census Bureau laid off some 158,000 temporary workers in August, helping drag total government payrolls down by 122,000.

The rest of the economy -- the private sector -- created 17,000 new jobs in August.

But even that number overstates the slowdown in the pace of job growth. A strike by Verizon Communications (VZ Quote) employees temporarily subtracted 85,000 jobs from August payrolls, the Labor Department said. Meaning that the rest of the private sector created 102,000 new jobs for the month.

Factoring out the Census and the Verizon strike, the economy created 138,000 new jobs.

That's the important number, and it indicates slowing job growth because it falls well below the average pace of private-sector job growth over the last year. During the previous 12 months, private-sector payrolls added an average of 190,000 jobs a month. Last year, private payrolls grew by an average of 202,000 a month.

"The report is consistent with the view that the economy has downshifted in terms of growth," Breimyer said. "The markets like it, the Fed likes it, what's there not to like?"

The number came in significantly weaker than most economists expected. Breimyer expected news jobs -- after factoring out the census and strike -- to rise by 175,000. Another economist, Carol Stone at Nomura Securities, expected an increase of around 210,000.

Friday's jobs data is only the latest of a smorgasbord of economic indicators that reflect a slowing economy, the result of a steady campaign of raising interest rates by the Federal Reserve. Over the last 14 months, the Fed raised interest rates six times in an effort to cool the economy and stem the threat of inflation. In recent months, the numbers indicate the Fed has been successful. The manufacturing sector in particular has slowed considerably, as durable goods orders and factory orders plunged recently.

"U.S. workers should raise a glass to Alan Greenspan and the Fed this Labor Day weekend," said Bill Cheney, chief economist at John Hancock Financial Services.

The steep decline in manufacturing jobs, which fell by 79,000 in August after posting 51,000 new jobs in July, surprised some economists. "That was much more potent than I assumed," said Stone, the deputy chief economist at Nomura Securities. "It shows a downward trend in manufacturing."

Also Friday, another key barometer of the manufacturing sector showed a similar trend. The National Association of Purchasing Management said its broad index of activity in American factories fell to 49.5 in August from 51.8 in July. Any reading above 50 means business is growing for manufacturers, while below means business is contracting. It was the first time in 18 months that the index fell below 50.

In the same report, NAPM's Price Index showed the rate of increase for prices paid for raw materials slowed in August to its lowest rate since July 1999. The index fell to 56.2 from 61.9, an indication that inflation remains benign.

The amount of money spent on construction also declined in July, offering one more nugget of data to validate the view that the U.S. economy is slowing enough for the Fed to keep interest rates steady in the near-term. Construction spending fell to a seasonally adjusted rate of $789 billion in July, or a 1.6% decline from June, according to the Commerce Department. A group of economists polled by Reuters expected construction spending to increase 0.2%.

The Fed left interest rates unchanged at its Aug. 22 meeting, and most economists consider it a foregone conclusion that rates will remain steady at least until after the November presidential elections.

The other components of the August jobs report also testified to a cooling labor market. The unemployment rate edged up to 4.1% from 4%. It had been forecast to remain at 4% by economists polled by Reuters. And average hourly earnings rose by a nonthreatening 0.3%, as expected. That increase lifted the annual rate of earnings growth to 3.8% from 3.7%, but that is well below the threshold that economists consider inflationary.

The only potentially threatening news in the report was a small drop in the pool of available workers and an associated small drop in the augmented unemployment rate to 6.9% from 7.0%. The pool of available workers fell to 10.042 million from 10.128 million. However both measures remain off their cycle lows, reached in June.