U.S. job growth cools, unemployment rate rises

(Adds auto sales, updates markets to close)

* Nonfarm payrolls increase 209,000 in July

* Jobless rate rises as workforce expands

* Average hourly earnings up 1 cent, workweek steady

* Consumer spending up in June, but inflation retreats

By Lucia Mutikani

WASHINGTON, Aug 1 (Reuters) - U.S. job growth slowed a bit

in July and the unemployment rate unexpectedly rose, pointing to

slack in the labor market that could give the Federal Reserve

room to keep interest rates low for a while.

Nonfarm payrolls increased 209,000 last month after surging

by 298,000 in June, the Labor Department said on Friday.

Economists had expected a 233,000 job gain.

Although job growth was below expectations, July marked the

sixth straight month employment expanded by more than 200,000, a

signal of strength last seen in 1997. In addition, data for May

and June was revised to show 15,000 more jobs created than

previously reported.

The one tenth of a percentage point increase in the

unemployment rate to 6.2 percent came as more people entered the

labor market, an indication of confidence in job prospects.

"It's a goldilocks report for an economy that is steadily

expanding but not lifting off. It will reinforce for now the

Federal Reserve's commitment to a gradualist policy approach,"

said Mohamed El-Erian, chief economic advisor at Allianz in

Newport Beach, California.

U.S. Treasury debt prices rose as traders trimmed bets the

Fed would push rates up in the first half of next year, with the

liftoff date predicted by futures contracts moving to July from

June. A Reuters poll of top bond firms similarly found

economists predicting a move in the second half of 2015.

U.S. stocks briefly gained as the prospect of continued low

rates soothed investors after a sharp sell-off on Thursday, but

ended down on persisting worries over Argentina's debt default.

The dollar fell against a basket of currencies.

The report showed average hourly earnings, which are being

monitored as an early warning sign of inflation pressures, rose

only one cent. That left the annual growth rate at 2.0 percent,

well below levels that would make the Fed nervous. Some other

measures that have shown wages rising more briskly have some

economists worried the central bank could fall behind the curve.

Fed policymakers on Wednesday cautioned that "significant"

labor market slack remained, signaling patience on the rate

front. The central bank has kept benchmark rates near zero since

December 2008.

LITTLE INFLATION

A separate report from the Commerce Department showed

inflation easing in June. A price index for consumer spending,

excluding food and energy, edged up 0.1 percent after gaining

0.2 percent in May.

In the 12 months through June, the index was up just 1.5

percent, still below the Fed's 2 percent target.

The same report showed income grew 0.4 percent.

"We are looking for stronger earnings gains as slack in the

labor market dissipates," said Scott Anderson, chief economist

at Bank of the West in San Francisco.

The cooling in hiring did little to change expectations for

strong economic growth in the third quarter. The Institute for

Supply Management reported that factory activity rose to its

highest level in more than three years in July, buttressing

those expectations.

The rise was driven by a surge in orders and hiring.

Separately, automakers reported that July sales increased

9.1 percent from a year ago to a seasonally adjusted annualized

rate of 16.48 million units. The pace, however, was down a bit

from June's 16.80 million units.

The economy grew at a 4.0 percent annual pace in the second

quarter after shrinking at a 2.1 percent rate in the first three

months of year. While restocking by businesses lifted the

figure, growth is seen remaining sturdy for the rest of 2014.

A fifth report showed consumer sentiment little changed in

July as households kept an eye on the steadily improving labor

market. The unemployment rate has declined from a peak of 10

percent in October 2009. While Americans leaving the workforce

has been a factor, job gains have also contributed to the drop.

"The job market has moved from a 'fake recovery,' with

unemployment falling due to people abandoning the labor force,

to a real recovery of steady 200,000-plus payroll gains," said

Ethan Harris, global economist at Bank of America Merrill Lynch

in New York.

The labor force participation rate, or the share of

working-age Americans who are employed or at least looking for a

job, increased to 62.9 percent in July after holding at 62.8

percent for three consecutive months.

But other measures closely watched by Fed Chair Janet Yellen

took a step back.

A broad measure of joblessness that includes people who want

to work but have given up searching and those working part-time

because they cannot find full-time employment edged up to 12.2

percent. It had touched its lowest level in more than 6-1/2

years in June.

At the same time, the ranks of the long-term unemployed

swelled and the length of time Americans are spending unemployed

rose after reaching its lowest point in more than five years in

June.

July's job gains were broad-based. Services industries

accounted for the bulk of the increase, adding 140,000

positions. That compared to a 232,000 job rise in June.

Manufacturing payrolls increased for the 12th month in a

row, adding 28,000 jobs. Construction employment advanced for

the seventh consecutive month, with July payrolls rising 22,000.

Government employment increased by 11,000 jobs.

The length of the average workweek held steady at 34.5

hours.

(Reporting by Lucia Mutikani; Additional reporting by Jennifer

Ablan and Rodrigo Campos in New York; Editing by Andrea Ricci)