The weaker-than-expected US jobs report for July is likely to strengthen the position of officials who favor keeping interest rates unchanged, while potentially shifting the Federal Reserve's attention back toward the health of the labor market if employment growth continues to deteriorate.

However, unless a clearer pattern of labor-market weakness emerges, Fed officials are still likely to keep inflation as their primary concern.

Nonfarm payrolls fell by 23,000 in July, compared with expectations for an increase of 80,000. Previously reported employment figures for May and June were also revised lower by a combined 103,000 jobs.

The unemployment rate declined to 4.1% from 4.2% in June, alongside another drop in the labor force participation rate. Since January, the participation rate has fallen by 0.7 percentage point.

Local government education led the job losses, shedding 50,000 positions, followed by retail, which lost around 20,000 jobs, and the financial sector, which cut 14,000. Healthcare, by contrast, added 22,000 jobs.

Thomas Ryan, chief economist at Capital Economics, said the weakness in July hiring has not yet been reflected across the broader range of labor-market indicators, but is likely to revive Fed officials' concerns about the strength of the jobs market and make them less willing to commit to near-term monetary tightening.

He added that it would likely take a significant upside surprise in next week's inflation data for the Fed to raise interest rates in September.

Labor market in a fragile balance

Tom Barkin, president of the Federal Reserve Bank of Richmond, said Friday's employment report was broadly consistent with his view of a labor market that is neither excessively weak nor particularly strong, but instead operating in a fragile balance.

Speaking during a webinar organized by the National Association for Business Economics, Barkin said his conversations with businesses suggest that companies are still reluctant to hire new workers, but are also not laying them off.

He said the labor force is no longer growing amid lower immigration, demographic changes and more people aging out of the workforce.

Barkin said the US economy is operating in an environment where labor-force growth is roughly zero, while employment growth ranges from zero to modestly positive, a situation he believes has persisted for the past year to year and a half.

Earlier this week, Fed Governor Lisa Cook, who supported keeping interest rates unchanged at the July meeting, said she was prepared to act if she did not see signs of inflation easing soon.

She added that she would also consider the impact of higher interest rates on labor-market stability, explaining that a rate increase would remain an option if necessary to bring inflation down, although some disinflationary forces are already in place and could push inflation toward the Fed's target without requiring additional tightening.

Inflation remains the decisive factor

Earlier this year, when employment growth was similarly volatile, some Fed officials argued that zero job growth could still be consistent with a labor market in balance.

Mary Daly, president of the Federal Reserve Bank of San Francisco, said at the time that changes in government policies that reduced immigration and pushed labor-force growth toward zero meant that traditional rules for assessing the health of the labor market were changing.

Fed Governor Christopher Waller also said earlier this year that zero employment growth would not necessarily prevent the labor market from being considered balanced, particularly if the unemployment rate remained stable because of changes in immigration.

Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, said Friday's weak employment report could ease pressure on the Fed to raise interest rates at its September meeting, but next week's inflation data would likely remain the decisive factor.

She added that if inflation comes in hotter than expected, the slowdown in the labor market may not be enough to silence calls within the Fed for a rate increase or significantly reduce market expectations for further tightening.