Jan. 4 (Bloomberg) -- Hiring in the U.S. slowed more than forecast in December and unemployment jumped to a two-year high, raising the odds that the Federal Reserve will cut interest rates by half a point this month to ward off a recession.

Payrolls rose by 18,000, capping the worst year for job creation since 2003, the Labor Department said today in Washington. The jobless rate increased to 5 percent from 4.7 percent in November, while the Institute for Supply Management said growth in U.S. service industries cooled last month.

Treasuries rallied, the dollar fell and stocks slid after the jobs report indicated more damage to the economy from the housing slump and reduced access to credit. The figures may also strengthen calls for President George W. Bush to stimulate the economy during his final year in office.

``It's time for the Fed to step up to the plate and let the public know how they're going to play this,'' said Maury Harris, chief economist at UBS Securities LLC in New York. ``This is a very vulnerable economy right now.''

Excluding a gain in government jobs, payrolls fell last month for the first time since July 2003, hurt by losses in manufacturing, construction and the retail industry.

``This tells you that the strains from credit problems and so forth that have been developing the last six months are starting to bite and they're biting in a way that now finally draws consumption into question,'' said Neal Soss, chief economist at Credit Suisse Group Inc. in New York.

Markets React

Yields on benchmark 10-year Treasury notes fell to 3.86 percent at 4:11 p.m. in New York from 3.89 percent late yesterday. The dollar fell 0.7 percent to 108.52 yen, while closing little changed against the euro. The Standard & Poor's 500 Index lost 2.5 percent to 1,411.6.

Shares of retailers, homebuilders and automakers in the S&P 500 are down 6.1 percent in the first three days of 2008. The group fell 14 percent last year, trailing only financial companies, which lost 21 percent.

``Today's unemployment numbers are discouraging, and they undoubtedly raise the possibility of a fiscal-stimulus package,'' said Douglas Elmendorf, a former Treasury and Federal Reserve Board official, and now a senior fellow at the Brookings Institution in Washington.

Edward Lazear, chairman of the White House Council of Economic Advisers, said the Bush administration will consider measures to stoke the economy.

More `Steps'

``We have pushed economic growth policies throughout this administration and we're not going to stop doing that now,'' Lazear said in a Bloomberg Television interview in Washington. ``If there are necessary steps that need to be taken, the president will be considering those over the next few weeks.''

The ISM index of non-manufacturing businesses, which make up almost 90 percent of the economy, fell to 53.9 from 54.1 the prior month, the Tempe, Arizona-based ISM said. Readings above 50 signal growth.

Economists surveyed by Bloomberg News had forecast a gain of 70,000 in payrolls, according to the median estimate, from an originally reported gain of 94,000 for November. The November job increase was revised up to 115,000 today.

The December job gain puts the total payroll increase for 2007 at 1.33 million, the fewest in four years. The unemployment rate for 2007 averaged 4.6 percent. The last time the jobless rate rose more in a single month was April 1995.

`Close' to Recession

``It's not a done deal, but if we're going to have a recession, it's too late to do anything about it,'' said Stuart Schweitzer, global markets strategist at JPMorgan Wealth & Asset Management in New York. ``The Fed can't prevent a recession if one's in the making, and we're pretty close.''

Traders increased bets the Fed will lower its benchmark rate by a half-point to 3.75 percent at the next meeting, on Jan. 29-30. The odds of such a move rose to 42 percent today from 34 percent yesterday and zero at the start of the week, futures prices show.

Today's figures were even worse than a private survey yesterday that indicated a cooling job market. Companies hired 40,000 workers in December, according to data compiled by ADP Employer Services. The figures include only private employment and don't take into account hiring by government agencies.

Service industries, which include banks, insurance companies and restaurants, added 93,000 workers last month after gaining 160,000 jobs in November. Retail employment declined by 24,300 after increasing 32,000 in November.

Factories, Builders

Factory payrolls decreased by 31,000 after falling 13,000 a month earlier. Economists had forecast a drop of 15,000 in manufacturing employment. Builders reduced payrolls by 49,000 after cutting 37,000 jobs in November.

Government payrolls increased by 31,000 during the month, indicating private payrolls declined by 13,000.

Residential construction started dropping at the start of 2006, weakening job growth as builders, mortgage companies and manufacturers reduced staff.

The collapse of the subprime mortgage market in July and August hastened firings at financial companies. National City Corp., Ohio's largest bank, said this week it would eliminate another 900 jobs, bringing total cuts to 3,400, or about 10 percent of its workforce, in one year.

The housing market ``corrected with a high degree of suddenness,'' Chief Executive Officer Peter Raskind said in an interview on Jan. 2.

Cutbacks

Manufacturers are also cutting back as sales of building materials, appliances and furniture weaken, reflecting a 34 percent slump in combined new and existing home sales from their July 2005 peak.

Factories have already slowed. ISM's manufacturing index for last month fell to 47.7, the lowest since April 2003, the purchasers group said this week.

Today's report showed hourly wages rose 7 cents, or 0.4 percent, on average to $17.71 in December and were up 3.7 percent from a year earlier. Economists had expected a 0.3 percent increase for the month and 3.6 percent for the 12-month period.

Average weekly hours worked by production workers were unchanged at 33.8. Average weekly earnings rose to $598.60 last month from $596.23 the prior month.

The world's largest economy grew at a 1 percent pace in the fourth quarter after expanding at a 4.9 percent rate the previous three months that was the strongest since 2003, according to the median estimate of economists surveyed last month. Growth for all 2008 was projected at 2.3 percent.

To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: January 4, 2008 16:34 EST