A 7-Eleven convenience store has a sign in the window reading 'Now Hiring' in Cambridge, Massachusetts. / Reuters/Brian Snyder/File Photo

WASHINGTON (Reuters) - U.S. job growth likely slowed to a still-healthy pace in June, with the unemployment rate holding steady at 4 percent, increasing the chances that the Federal Reserve will be able to tame inflation without tipping the economy into recession.

The Labor Department's closely watched employment report on July.5 is also expected to show annual wage growth rising at its slowest rate in three years. When added to the moderation in prices in May, the report would confirm that the disinflationary trend was back on track after inflation surged in the first quarter.

It also could boost Fed policymakers' confidence in the inflation outlook and push the U.S. central bank a step closer to start cutting rates later this year.

Financial markets remain optimistic the Fed could start its easing cycle in September after aggressively tightening monetary policy in 2022 and 2023. Fed Chair Jerome Powell said this week that the economy was back on a "disinflationary path," but stressed policymakers needed more data before cutting rates.

"The economy is moving into a reasonable and sustainable, pace of employment growth," said Brian Bethune, an economics professor at Boston College. "There's no evidence of any sudden decline, nothing that would suggest we're suddenly going to tip over. We're still basically tracking a 'soft landing.'"

Nonfarm payrolls likely increased by 190,000 jobs last month after surging by 272,000 in May, according to a Reuters survey of economists. Employment gains have averaged about 230,000 jobs per month over the past 12 months.

Economists say the economy needs to create at least 150,000 jobs per month to keep up with growth in the working-age population, accounting for the recent surge in immigration.

The jobless rate rose to 4.0 percent in May for the first time since January 2022, boosted by volatile youth unemployment. Some economists expected it to drop back to 3.9 percent in June.

A lagging measure of employment, the Quarterly Census of Employment and Wages (QCEW), has suggested a much slower pace of job growth through the fourth quarter of 2023 than that of the payrolls data. The QCEW data is derived from reports by employers to the state unemployment insurance (UI) programs.

BENCHMARK ESTIMATE

But economists argue the QCEW data does not include undocumented immigrants, a group that they believe contributed to strong job growth last year. The Labor Department's Bureau of Labor Statistics will publish next month its payrolls benchmark estimate for the 12 months through March of this year.

"Payrolls are on track to be revised downward, but we believe that's not because payrolls are overcounting but because QCEW is undercounting," said Sam Coffin, an economist at Morgan Stanley. "Because QCEW is based on UI records, it likely misses counting those who are not authorized to work. If one's not authorized to work, one also is not eligible for unemployment insurance benefits. In contrast, the payroll survey asks that employees be counted regardless of legal status."

Hiring has been largely driven by sectors like healthcare, leisure and hospitality as well as state and local government education, which has seen staffing levels head back to pre-pandemic levels. That trend likely persisted in June, though at a more moderate pace than in the past months.

Employment in these sectors is mostly back at 2019 levels, and the 525 basis points worth of rate hikes from the Fed since 2022 to curb inflation has weighed on business formation.

Excess savings accumulated during the COVID-19 pandemic have been exhausted, contributing to a slowdown in demand for both labor, goods and services.

"There's been a lot of the catch-up hiring that needed to be done to get businesses re-staffed again," said Sarah House, a senior economist at Wells Fargo. "That's largely complete across a lot of different sectors."

Even as the labor market is cooling, wage growth remains sufficient to sustain consumer spending and the overall economic expansion.

Average hourly earnings are forecast to have risen 0.3 percent in June after climbing 0.4 percent in May. That would lower the annual increase in wages to 3.9 percent, the smallest gain since June 2021, from 4.1 percent in May. Wage growth in a 3-3.5 percent range is seen as consistent with the Fed's 2 percent inflation target.

The central bank has maintained its benchmark overnight interest rate in the current 5.25-5.50 percent range since last July. The minutes of the Fed's June 11-12 meeting, which were published on July.3, showed policymakers acknowledged the economy appeared to be slowing and that "price pressures were diminishing."

Economists argue the labor market is not driving up inflation, noting that worker productivity has picked up, and worry that the Fed could stifle growth by keeping borrowing costs elevated for too long.

"Wage growth had been high earlier in this expansion, but it's come down, said Kevin Rinz, a senior fellow at the Washington Center for Equitable Growth. "Productivity growth has returned to the normal relationship it has with wage growth such that there's not a huge gap between those two. It doesn't really seem necessary at this point to be constraining the labor market for the sake of reducing inflation."