Now, it's employment that's weak

NEW YORK (CNNMoney.com) -- The number of Americans with jobs fell in August for the first time in four years, according to Friday's government employment report, raising fears that weakness in the economy has spread beyond the housing and financial sectors that have roiled markets in recent weeks.

Stocks fell sharply on new worries that the economy will stay sluggish for the rest of this year and into 2008, and it now appears likely that the Federal Reserve will be forced to cut interest rates in an attempt to stop the economy from falling into recession.

The Labor Department report showed was a net loss of 4,000 jobs in the month, down from the 68,000 increase in July, which was also revised lower. Economists surveyed by Briefing.com had forecast an increase of 110,000.

The unemployment rate stayed at 4.6 percent in August, despite the drop in payrolls, which was in line with economists' forecasts.

The unemployment rate is calculated using a separate survey of households, rather than the employer survey used to count those on U.S. payrolls. The employer survey is generally considered more reliable by economists.

The household survey actually showed an even larger drop in the number of Americans saying they had jobs - a drop of 316,000. But the unemployment rate stayed unchanged because those counted as unemployed also decreased by 24,000, and there was a big jump in those counted as not being in the labor force, a number that rose by 592,000.

The July gain in payrolls was revised 24,000 lower, while the June increase was also cut by 57,000 from its previous reading, the second time the June gain has been trimmed since the original report. The 81,000 fewer jobs in the earlier months than previously reported was also a cause for concern among economists.

"It's not just August anymore after those revisions," said Robert Brusca of FAO Economics. "If job losses in the finance, insurance and real estate sectors are yet to hit the tape and if there are any knock-on effects, then we are facing potentially very weak job conditions ahead."

The August jobs report was being particularly closely watched by investors and economists for clues as to what the Federal Reserve will do with interest rates when it meets on Sept. 18.

There is greater uncertainty than normal as to what the Fed will do with its benchmark rate in the face of turmoil in the nation's credit and financial markets. The report is widely seen as making a rate cut certain, but it has raised a debate as to whether it will be a quarter-percentage point or half-point reduction.

John Silvia, chief economist for Wachovia, said that he believes the Fed will be reluctant to make the more drastic half-point cut, although there will certainly be many people calling for them to do so.

"I know the Fed doesn't want to panic, but they've got to be scrambling," he said. "My guess is given their academic background and institutional history, they'll still go with a (quarter point)."

Gus Faucher, director of macroeconomics for Moody's Economy.com, agreed that he still thinks a quarter-point cut is the most likely course for the central bank, but he believes it will be followed by another quarter point cut at the following meeting Oct. 31. And he said the chance of a half-point cut right off the bat has risen to roughly one-in-four from almost no chance before Friday's report.

"The downside risks to the economy have certainly increased," he said. "I don't expect to see consistent job losses, but I think its weakness will persist well into 2008."

Economists said that it is possible the August reading is an anomaly. Future revisions may take the payroll number back into positive territory. The initial payroll readings for September 2005 showed an even larger decline in the wake of Hurricane Katrina, although that reading was later revised into positive territory.

But Silvia said even if that were to happen, the revisions wouldn't mask the underlying weakness now in the labor market and the economy.

"I think the fact it's negative is probably an outlier. The fact that it's weak is not an outlier," he said. "You look at the three-month moving average, and it's a clear trend that it's moving down.

Despite the markets' desire for a rate cut, stocks plunged following the report due to concerns that economic weakness is greater than had been feared. The Dow Jones industrial average was down more than 200 points in late morning trading. Bond prices rose, taking the yield on the 10-year note down to 4.41 percent, the lowest interest rate on that closely-watched bond since December.

While construction lost 22,000 jobs in August due to a slowdown in home building and real estate, that wasn't the sector that saw the biggest drop. Manufacturing employment fell by 46,000 jobs, while government payrolls were trimmed by 28,000.

Average hourly wages edged up 0.3 percent to $17.50 an hour. That was in line with economists' forecasts, and it means that wages have now risen 3.9 percent over the last 12 months.

A separate Labor Department report shows consumer prices have risen only 2.4. percent in the 12 months ending in July, meaning that workers' wages have outpaced price increases.