Companies add more jobs, but manufacturing falters

NEW YORK (Reuters) - U.S. companies hired more workers than expected in July, but continued weakness in the manufacturing sector pointed to sluggish economic growth.

The economic recovery has lost steam in recent months as it has been buffeted by the euro zone debt crisis, a struggling U.S. labor market and concerns over higher taxes and government spending cuts that are set to take place early next year.

Economists said Wednesday's data suggested further slow growth after a 1.5 percent growth rate in the second quarter, though the economy should avoid recession. The reports were not bad enough to raise expectations of more aggressive action from the Federal Reserve.

"I don't see any evidence that the weakness is truly feeding on itself at this point but at the same time, there's no obvious spark for the economy to look a lot better in the next few months, either," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics in New York.

Federal Reserve policymakers on Wednesday head into the second day of a two-day meeting with investors watching to see if the central bank will unveil fresh measures to bolster the economy.

While some are looking for a third round of bond purchases, analysts believe the central bank could instead push back its guidance for when it sees an interest rate hike and hold off on quantitative easing until at least its next meeting in September.

"Today's numbers certainly don't force them to go quickly in terms of acting," said O'Sullivan. "It clearly keeps them moving toward action but not necessarily today."

High unemployment and weak consumer confidence took a toll on U.S. automakers as all three reported lower-than-expected sales for July.

The ADP National Employment Report showed private employers created 163,000 jobs in July, more than the 120,000 that had been expected though slightly less than June's 172,000. June was originally reported as 176,000.

"The U.S. continues to have consistently positive private sector payroll growth, albeit at a painfully slow rate," said Eric Stein, VP and portfolio manager at Eaton Vance Management in Boston.

The ADP figures come ahead of the government's much more comprehensive labor market report on Friday, which includes both public and private sector employment.

That report is expected to show nonfarm payrolls rose by a modest 100,000 last month, while the unemployment rate is seen staying the same at 8.2 percent.

Economists estimate the labor market needs to create about 125,000 jobs a month to keep the unemployment rate steady, though estimates vary.

Analysts often refer to the ADP report to fine-tune their expectations for the payrolls numbers, though it is not always accurate in predicting the outcome.

The ADP report has differed from the government's private jobs number by an average of about 50,000 so far this year, said Cooper Howes, economist at Barclays.

If that continues, it would be in line with a forecast for a gain of 100,000 nonfarm payrolls last month, said Howes.

U.S. stocks were little changed in the late morning as investors awaited the Fed announcement, while unusual trading roiled seemingly unrelated shares on the NYSE.

Two separate reports on manufacturing - previously a tent pole of the recovery - showed the sector continued to falter.

A report from the Institute for Supply Management showed manufacturing activity contracted for a second month in a row in July as new orders improved modestly but employment dropped to a 2-1/2-year low.

ISM's index of national factory activity inched up to 49.8 from 49.7 in June, shy of economists' expectations for 50.2. A reading below 50 shows contraction in the sector.

Forward-looking new orders remained in contraction territory but improved to 48 from 47.8. The gauge of employment slid to its lowest since December 2009 at 52 from 56.6.

Exports continued to tumble and were down at 46.5 from 47.5. The index has lost 13 points since February.

A survey from Markit showed manufacturing fared slightly better than ISM indicated as the sector managed to grow, though the pace was the slowest in nearly three years.

The final Markit U.S. Manufacturing Purchasing Managers Index fell to 51.4 from 52.5 in June as it was also hurt by falling export orders.

Overseas, manufacturing activity in the euro zone contracted for the 11th straight month in July as the downturn deepened. As well, China's official measure of factory activity fell to an eight-month low.

Separate data showed U.S. construction spending rose modestly in June as investment in new homes and home improvement countered a drop-off in public works projects funded by the federal government.

Another report showed lending to small businesses fell in June to the lowest level since October with the Thomson Reuters/PayNet Small Business Lending Index falling to 98.5 from 103.8 in May.

(Additional reporting by Steven C. Johnson in New York and Jason Lange in Washington, editing by Dave Zimmerman)