Aug. 4 (Bloomberg) -- U.S. employers added fewer jobs than forecast in July and the unemployment rate rose, increasing the likelihood the Federal Reserve will forgo raising interest rates next week for the first time in two years.

The economy added 113,000 jobs, led by increases at health care providers, restaurants and engineering firms, following a 124,000 rise in June, the Labor Department said today in Washington. The unemployment rate rose to 4.8 percent from 4.6 percent, the first increase since February.

Bonds jumped while the dollar fell as traders judged the Fed will take a breather after pushing borrowing costs higher at each of the 17 policy meetings since June 2004. The report gives Fed policy makers the luxury of waiting a few months to gauge the breadth of the economic slowdown and whether inflation pressures abate.

``The Fed has been wanting to pause and this will be their opportunity,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic economic research at the New York Fed. ``This report takes the pressure off the Fed for now, but I don't think a pause means they're finished. There are still lots of hints of inflation in the system.''

Switching Camps

Economists at Morgan Stanley, RBS Greenwich Capital, HSBC Securities, UBS AG, and Barclays Capital, which all deal in Treasury securities directly with the Fed, changed their forecast to a pause next week rather than a quarter-point increase. Goldman Sachs Group Inc. and Deutsche Securities kept their call for a rise.

The rise in the unemployment rate ``is a bit disconcerting when the jobless rate has been moving relentlessly downward for three years,'' said Stephen Stanley, chief economist at RBS in Greenwich, Connecticut. ``This may be a one-month blip, but if I'm on the FOMC, I would be willing to sit on my hands for six weeks just to make sure.''

The jump in the jobless rate makes it tougher for President George W. Bush to persuade voters his economic policies are working heading into mid-term elections later this year that will determine whether Republicans or Democrats control Congress. Almost three out of five Americans disapprove of the way Bush is handling the economy, according to a Bloomberg/Los Angeles Times poll released yesterday.

`Cements the Pause'

Economists expected a gain of 144,000 jobs last month, following an originally reported 121,000 increase in June, according to the median estimate in a Bloomberg News survey. The unemployment rate was expected to hold at 4.6 percent for a third month, according to the Bloomberg survey.

``This cements the pause,'' said Paul Kasriel, director of economic research at Northern Trust Securities in Chicago and a former Fed economist. ``We have had four months in a row of subdued employment growth, and that is fairly significant evidence of the slowdown.''

The yield on the benchmark 10-year U.S. Treasury note fell 6 basis points to 4.90 percent at 4:30 p.m. in New York.

U.S. stocks initially climbed before retreating as concern about slower growth outweighed anticipation the Fed will abstain from lifting rates next week. The Standard & Poor's 500 Index fell 0.91 points, or 0.07 percent, to 1279.36.

Wage Growth

Wages are holding up even as fewer jobs are being created, which economists say will help give consumers the means to keep spending. Average hourly earnings in July rose 0.4 percent for a second month. Economists expected a 0.3 percent gain. Compared with the same month last year, hourly earnings were up 3.8 percent after gaining 3.9 percent in the 12 months ended in June.

``Probably the best news in these numbers is not the job numbers so much, although those are positive, but the wage numbers,'' Edward Lazear, chairman of the White House Council of Economic Advisors, said in an interview.

The probability of the central bank increasing its target for the main U.S. rate to 5.5 percent dropped to 21 percent from 41 percent, based on the price of futures tied to the rate on the Chicago Board of Trade. Trading suggests it's about an even chance whether the central bank lifts borrowing costs once more before yearend.

``This report is definitely limp enough to rule out a rate hike at the August meeting,'' said John Lonski, chief economist at Moody's Investors Service in New York. ``Unless the labor market begins to recover, who knows, several months from now we might be talking about a rate cut.''

The average gain in payrolls for the second quarter, 112,000, was the lowest since July through September 2003.

Labor Force

The U.S. doesn't need to create as many jobs as it did in the past to keep unemployment low and support the economy because fewer people are entering the labor force, economists said.

Monthly payroll growth of ``more like 130,000,'' and possibly less, is what the economy needs to keep unemployment stable, Fed Chairman Ben S. Bernanke said in testimony before the Senate Banking Committee on July 19.

Last month's sluggish payroll growth may also be the result of a shortage of skilled labor, economists said.

The U.S. unemployment rate is the third-best in the Group of Seven economies, behind the United Kingdom's 3 percent and Japan's 4.2 percent for June, according to Bloomberg data. The UK is scheduled to release its July claimant count rate on Aug. 16 and Japan will report its jobless rate on Aug. 28. Germany's rate is 10.6 percent.

Manufacturing

The manufacturing workweek rose to 41.5 hours and overtime dropped to 4.5 hours. Factories shed 15,000 jobs in July, after adding 22,000 the month earlier.

Continued low unemployment may bring higher salaries, economists said. Even so, companies don't seem to be passing higher labor costs on to their customers, which should make inflation pressures from wages less of a concern for the Fed, economists said.

Fed policy makers raised the target rate for overnight loans between banks to 5.25 percent at their last meeting June 29. The Fed has raised the rate 17 times since June 2004.

Slacker Spending

Consumer spending growth in the U.S. probably will end the year at a 2.7 percent annual rate, according to a Bloomberg News survey of economists taken from June 30 to July 10. Spending rose at an annual rate of 2.5 percent in the second quarter and 4.8 percent the first three months of the year.

``We have seen no signs whatsoever that our business is slowing,'' Lew Frankfort, chief executive officer of Coach Inc., said in an Aug. 1 interview.

Coach, the largest U.S. luxury leather-goods maker, is accelerating store openings to tap demand in markets such as Texas, Georgia and Florida. The New York-based company raised its profit forecast for the year because of greater demand.

Some companies continue to trim payrolls to boost profit.

Eastman Kodak Co. CEO Antonio Perez said on Aug. 1 that the company may cut as many as 2,000 more jobs than previously planned, or 27,000 in all, at a cost of as much as $3.4 billion. Rochester, New York-based Kodak, the world's largest photography company, yesterday posted a seventh straight quarterly loss.

To contact the reporter on this story: Courtney Schlisserman in Washington cschlisserma@bloomberg.net

Last Updated: August 4, 2006 16:37 EDT