WASHINGTON (Reuters) -U.S. employment growth slowed more than expected in July while the nonfarm payrolls count for the prior two months was revised down by a massive 258,000 jobs, pointing to a deterioration in labor market conditions that puts a September interest rate cut by the Federal Reserve back on the table.

The Labor Department's closely watched employment report on Friday also showed the unemployment rate rose to 4.2% last month amid a decline in the volatile household employment segment. People also continued to leave the labor force, though the pace slowed from the prior months.

The U.S. central bank on Wednesday left its benchmark interest rate in the 4.25%-4.50% range. Fed Chair Jerome Powell's comments after the decision undercut confidence the central bank would resume policy easing in September as had been widely anticipated by financial markets and some economists.

Job growth has slowed amid uncertainty over where President Donald Trump's tariff levels will eventually settle. Trump on Thursday slapped dozens of trading partners with steep tariffs ahead of a Friday trade deal deadline, including a 35% duty on many goods from Canada. The labor market is weakening at a time when tariffs are starting to boost inflation. 

"The door to a Fed rate cut in September just got opened a crack wider," said Christopher Rupkey, chief economist at FWDBONDS. "The labor market is not rolling over, but it is badly wounded and may yet bring about a reversal in the U.S. economy's fortunes.

Nonfarm payrolls increased by 73,000 jobs last month after rising by a downwardly revised 14,000 in June, the fewest in nearly five years, the Labor Department's Bureau of Labor Statistics said. Economists polled by Reuters had forecast payrolls would increase by 110,000 jobs after rising by a previously reported 147,000 in June. Estimates ranged from no jobs added to an increase of 176,000 positions.

Payrolls for May were slashed by 125,000 to only a gain of 19,000 jobs. The BLS described the revisions to May and June payrolls data as "larger than normal." 

It gave no reason for the revised data but noted that "monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors."

Job gains in July continued to be concentrated in the healthcare sector, which added 55,000 positions. Social assistance employment increased by 18,000 jobs.

But federal government employment dropped by another 12,000 positions and is down 84,000 since peaking in January. More job losses are likely after the Supreme Court gave the White House the green light for mass firings as Trump seeks to slash spending and headcount. But the administration has also said several agencies were not planning to proceed with layoffs.

Financial markets expect the Fed to resume its monetary policy easing next month after pushing back rate cut expectations to October in the wake of Wednesday's policy decision. 

The dollar fell versus a basket of currencies. U.S. Treasury yields dropped.

DOWNSIDE RISK

Though Powell described the labor market as being in balance because of supply and demand both declining simultaneously, he acknowledged this dynamic was "suggestive of downside risk." 

The Trump administration's immigration crackdown has reduced labor supply, as has an acceleration of baby boomer retirements.

The reduction in immigration flows means the economy now needs to create roughly 100,000 jobs per month or less to keep up with growth in the working-age population, economists estimated. The decline in the unemployment rate to 4.1% in June was in part due to people dropping out of the labor force.

The increase in July still left the jobless rate in the narrow 4.0%-4.2% range that has prevailed since May 2024. 

The case for a September rate cut could be reinforced by the BLS' preliminary payrolls benchmark revision next month, which is expected to project a sharp drop in the employment level from April 2024 through March this year. 

The Quarterly Census of Employment and Wages data, derived from reports by employers to the state unemployment insurance programs, has indicated a much slower pace of job growth between April 2024 and December 2024 than payrolls have suggested.