Fed rate cut debate in view as U.S. job market cools

By Ann Saphir

(Reuters) -Federal Reserve policymakers got more evidence of labor-market cooling on Friday that could boost their confidence they are winning their fight on inflation, and open the path to a more active debate on interest-rate cuts when they next meet in late July.     The Labor Department's monthly report showed the unemployment rate rose in June to 4.1%, and big revisions to prior-month estimates of job creation meant the average monthly payroll gain over the most recent three months downshifted to 177,000.

That's below the 200,000-a-month gain that Fed Governor Lisa Cook recently estimated the economy now needs to create just to keep up with immigration and other increases to the population.

Average hourly earnings were up 3.9% from a year earlier, the report also showed, below a 4% pace for the first time in three years and a sign that price pressures are on the ebb.

U.S. central bankers meeting July 30-31 are not expected to change their policy rate from the 5.25%-5.5% range it has been in since last July.

But the new data, along with other recent reports suggesting that inflation is cooling and the economy is slowing, could put a rate cut at the following meeting in their sights.

"Overall, a moderation in payrolls in Q2 coupled with a rise in the unemployment rate and a slower growth path suggested by recent data bolster the case for rate cuts this year," said Rubeela Farooqi, Chief US Economist of High Frequency Economics. "We think the Fed could certainly start the discussion about cutting rates at the upcoming FOMC meeting, and lower the policy rate in September, if the data continue to show moderation."

Fed policymakers at their June meeting signaled they see just one interest-rate cut this year, a forecast that pointed to a December start to any policy easing.

Fed Chair Jerome Powell said they would need to be confident inflation is heading to their 2% goal before cutting rates.

He also said any unexpected weakening in the labor market could also trigger a rate cut.

The increase in the unemployment rate last month from 4% still leaves that widely-used gauge of labor-market health below levels historically associated with a recession.

But the rate, which was 3.7% in January and 3.5% last July, puts the economy closer to triggering what's known as the Sahm rule, an indicator for recession.

"We now have definitive evidence of U.S. labor market cooling with a somewhat alarming rise in the unemployment rate in recent months that should give policymakers 'more confidence' that consumer inflation will soon return to the 2% target on a sustainable basis," BMO chief U.S. economist Scott Anderson.

Powell is slated to address Congress on Tuesday and Wednesday, and investors will be watching keenly for how he views the latest data and what it means for the Fed's policy path.

On Thursday investors will get the June reading on the consumer price index, which last month showed inflation had resumed its cooling trend.

Financial markets are pricing in a September rate cut, with the implied probability remaining at about 72% after the June jobs report. Traders are pricing in a second rate cut in December.

(Reporting by Ann Saphir, Howard Schneider, Michael S Derby; Editing by Andrew Heavens and Chizu Nomiyama)