While the weaker-than-expected jobs report doesn't signal a retrenchment in the economy, it's hardly a ringing endorsement of it, and Federal Reserve officials will be taking note. The pace of employment and wage growth was subdued enough in June that one money manager declared the death of inflation, at least for now.

After three months of strong job growth, nonfarm payrolls increased just 112,000 in June, less than half the 250,000 consensus. Payrolls for both April and May were revised down, and the unemployment rate held steady at 5.6%.

"It was a soft number," said Gary Thayer, chief economist at A.G. Edwards. "We're still not out of the woods yet on the labor markets."

The details of the report were dramatic. Only 57% of 278 industries added jobs in June, the lowest since February and down from 64.6% in May. The average workweek fell by two-tenths of an hour to 33.6 hours, and the average manufacturing workweek fell by three-tenths to 40.8 hours. Total hours worked declined by 0.6%.

"We still have plenty of slack in the labor market, and these figures show job growth being well below the natural increase in the workforce," said Bill Cheney, chief economist at MFC Global Investment Management.

Many economists believe that the labor market is key to sustainable economic growth. The more jobs created, the more money consumers have to spend, and consumer spending accounts for two-thirds of economic growth.

"While I remain positive overall about the state of the economy, this report paints a distinctly weaker picture than we've seen over the past few months and was decidedly weaker than we expected," Cheney said.

The data throw into question just how many more rate hikes the market is likely to see this year. The Fed raised short-term interest rates by 25 basis points on Wednesday but repeated its claim to raise rates "at a pace that is likely to be measured." Before Friday's report, investors had been braced for a series of rate hikes and a funds rate of 2.25% by year-end.

"The surprisingly low job and wage figures cast some doubt on the Fed's next move on Aug. 10," said Sherry Cooper, chief economist at BMO Nesbitt Burns. "It is obviously still too early to rule out another 'measured' 25-basis-point increase, but these results should surely snuff out any speculation of a 50-pointer."

Gary Wolfer, senior portfolio manager at Univest Wealth Management, said he believes the Fed will move in 25-basis-point increments throughout this tightening cycle and expects the Fed funds rate to be sitting at 1.75% by year-end, up from 1.25% right now.

"I think inflation is dead," he said. "There's no sign of inflation in unit labor costs."

Average hourly earnings rose just 0.1% in June, below expectations for a 0.3% gain. Wages account for about two-thirds of the cost of production.

The weak jobs report Friday comes on the heels of other disappointing data. The ISM's manufacturing survey for June dipped from May, durable goods orders have fallen for two straight months, auto sales fell in June, and both Wal-Mart ( WMT) and Target ( TGT) have lowered guidance, perhaps indicating some softness in consumer spending.

Some economists said they were surprised by an 11,000 drop in manufacturing employment last month. While the Institute for Supply Management's employment index had declined in June from May, some pundits said it was still consistent with thousands of job gains.

Ian Shepherdson, chief economist at High Frequency Economics, said some of the weakness in the report reflects the change in the seasonal factor since June 2003, which cost some 79,000 jobs. He also said the Bureau of Labor Statistics' estimate for job creation was "inexplicably small," climbing just 18,000 year over year.

The BLS estimates the growth of new businesses each month, because there is a lag between an establishment opening for business and its appearance on the payroll sample. Over the past three months, roughly 65% of the new job creations came from government estimates, sparking some concern that payrolls were being overstated. In June, the BLS estimated that 182,000 jobs were created.

"The key here is that the trajectory for payroll employment growth slowed dramatically to 224,000 jobs on a three-month average basis, down from a three-month average of 304,000 the month before," noted Merrill Lynch chief economist David Rosenberg, who had been looking for a below consensus payroll number. "Higher interest rates appear to be working their magic."

While the Fed just raised short-term rates on Wednesday, long-term interest rates had already moved up sharply in anticipation of the event. When interest rates climb, it becomes more expensive to borrow money, and business spending tends to slow down.

The services sector contributed to most of the job gains in June, with 122,000 jobs added. Government payrolls fell by 5,000 and construction hiring was flat. Job gains in the previous two months were revised down by a total of 35,000, to 235,000 in May and 324,000 for April. A separate survey of households showed employment rose by 259,000 in June, while unemployment rose by 45,000.

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