Unemployment rate falls to 7.4 percent despite slower job growth due to shrinking labor force

WASHINGTON (Reuters) - U.S. employers slowed their pace of hiring in July but the jobless rate fell anyway, mixed signals that could make the U.S. Federal Reserve more cautious about drawing down its huge economic stimulus program.

The number of jobs outside the farming sector increased by 162,000, the Labor Department said on Friday.

That was below the median forecast in a Reuters poll of 184,000. Compounding that miss, the government also cut its previous estimates for hiring in May and June.

At the same time, the jobless rate fell two tenths of a point to 7.4 percent, its lowest in over four years. Gains in employment fueled some of that decline, but the labor force also shrank during the month, robbing some of the luster from the decline in the unemployment rate.

The data reinforces the view that the job market is inching toward recovery, with the broader economy still stuck in low gear.

"The U.S. economy is grinding along for the better, but it's going to be a long and slow grind," Tanweer Akram, an economist at ING U.S. Investment Management in Atlanta, said ahead of the report.

The question is whether the pace of job gains is enough for the Fed to feel the U.S. economy is ready to get by with less support. The U.S. central bank currently buys $85 billion a month in bonds to keep borrowing costs low.

The stimulus program has lowered interest rates, spurring growth in the country's beleaguered housing market and boosting car sales. Fed Chairman Ben Bernanke said last month the U.S. central bank would likely reduce the level of monthly purchases by the end of the year, and end them by mid-2014.

The Fed's policymaking committee wrapped up a two-day meeting on Wednesday without any change to the program. The panel's statement, however, referenced new factors that could be seen as risks to growth: a recent rise in mortgage rates and persistently low inflation. Central bank policymakers next meet in September.

STRUCTURAL CONCERNS

The growth in payrolls left the three-month average gain at 175,000. Many economists believe even hiring around that level could lead the Fed to trim its bond buying in September.

But Friday's jobs report could also entertain darker views on the economy.

For one, analysts wonder if the pace of job creation can be sustained given slower-than-expected economic growth.

Gross domestic product, a measure of the nation's economic output, grew at a mere 1.4 percent annual rate in the first half of the year, down from 2.5 percent in the same period of 2012.

Most economists expect GDP will accelerate in the second half of this year, which would make it more plausible for the current hiring trend to continue.

But the fact that job creation has been relatively robust despite weak output might point to a frightening possibility: perhaps the economy's growth potential has fallen.

This would mean less output is needed to create jobs, but that incomes would grow at a slower pace over the long run. The prospect of such a structural shift worries economists and investors.

"It's something we have been talking about a lot," Jeffrey Cleveland, a Los Angeles-based economist at investment management firm Payden & Rygel, said ahead of the report.

Friday's report showed the average work week declined to 34.4 hours, while average earnings slipped 0.1 percent.

(By Jason Lange. Reporting by Jason Lange; Editing by Andrea Ricci)

[A job-seeker completes an application at a career fair held by civil rights organization National Urban League as part of its annual conference, in Philadelphia July 25, 2013. REUTERS/Mark Makela]