By Steven C. Johnson
NEW YORK (Reuters) - Private sector employers added jobs in May and the economy's dominant services sector increased payrolls for the first time in more than two years, building evidence that the labor market was picking up steam.
New claims for unemployment insurance also fell last week, leaving investors braced for more good news on Friday, when the government's employment report is expected to show the economy added more jobs in May than at any time since September 1983.
"I think these reports show the labor market is in fact stabilizing. (Private employment) was slightly weaker than expected but foreshadows a good number tomorrow," said John Doyle, currency strategist at Tempus Consulting in Washington.
Consumers appeared withhold judgment about the job market, though, as U.S. retailers reported lackluster sales in May.
Private employers added 55,000 jobs last month, according to the ADP Employer Services report on Thursday, a bit weaker than forecast but still a sign of improved conditions, analysts said. April's job gain was revised upward to 65,000 from an initially reported tally of 32,000.
Economists expect Friday's more closely-watched payrolls report, which includes private and public sector jobs, to show that the economy added 513,000 jobs in May and the jobless rate dropped to 9.8 percent from 9.9 percent in April.
Two-thirds of expected hires were likely temporary ones tied to the 2010 U.S. Census, but such a total would still mark the most jobs added since September 1983, when the economy was pulling out of a deep recession. It would also be the fifth straight month of job gains.
In a separate report, the Labor Department said U.S. non-farm productivity grew at a 2.8 percent annual rate between January and March, the smallest advance in a year.
While some companies have held off hiring new workers, opting instead to add hours for the existing workforce, analysts said this policy cannot continue indefinitely, leading to an inevitable increase in payrolls.
"When the recovery first started, businesses could get more out of their existing workforces, but that's becoming more and more difficult," said Gus Faucher, director of macroeconomics for Moody's Analytics in West Chester, Pennsylvania.
U.S. stock indexes rose, though tepid May sales from Costco Wholesale Corp
In fact, discount chains turned in the best performance in May, suggesting consumers are being careful with their wallets despite signs of stronger job growth.
"There is still a high degree of caution in the markets," said Tim Ghriskey, chief investment officer at Solaris Management. "Many people don't want to step up in front of the jobs report."
RECOVERY STILL FRAGILE
Also on Thursday, the Labor Department said initial claims for state jobless benefits dropped 10,000 to a seasonally adjusted 453,000.
Service sector employment rose for the first time since December 2007, the month the United States fell into recession, the Institute for Supply Management said.
But while the economy has expanded for three straight quarters after enduring the worst downturn since the 1930s, stubbornly high unemployment is eroding President Barack Obama's popularity and could hurt his Democratic party in November's Congressional election.
Anthony Nieves, chairman of the ISM non-manufacturing survey committee, said service sector job growth was "really good news but warned, "I would want to see how it trends out.
"Because what everyone is stating is it's a jobless recovery, and I can't emphasize enough the long decline we've had," he said. "I don't want to minimize one month of growth, but I don't want to get overly optimistic."
Even jobless claims, while lower last week, have been stuck in a range of roughly 450,000 to 470,000 for months. That's above levels usually associated with sustainable employment growth.
What's more, the number of people still receiving benefits after an initial week of aid unexpectedly rose 31,000 to 4.67 million in the week ended May 22, the highest since early April, the Labor Department said.
TIGHTROPE FOR POLICYMAKERS
Even with high unemployment, the U.S. economy is nearly strong enough for the central bank to consider higher interest rates, a top Federal Reserve official said.
Another called for lifting rates to 1 percent from their current record low near zero by late summer.
Getting the timing right will be tricky, though, as policymakers in the United States and abroad attempt to shrink large budget deficits without putting the brakes on growth.
"That is the shared imperative," U.S. Treasury Secretary Timothy Geithner said in Washington this week before leaving for Thursday's meeting of G20 finance ministers in South Korea.
The U.S. economy grew at an annual pace of 3 percent between January and March, slowing from a 5.6 percent rate in the fourth quarter.
(Reporting by Steven C. Johnson and Lucia Mutikani, additional reporting by Burton Frierson, Ellen Freilich and Chuck Mikolajczak; Editing by Chizu Nomiyama )
