(Adds details, analyst comments, updates markets)
* Nonfarm payrolls increase 164,000 in July
* Unemployment rate holds steady at 3.7%
* Average hourly earnings rise 0.3%
* Trade deficit falls 0.3% to $55.2 bln in June
By Lucia Mutikani
WASHINGTON, Aug 2 (Reuters) - U.S. job growth slowed in July and manufacturers slashed hours for workers, which together with an escalation in trade tensions between the United States and China could give the Federal Reserve ammunition to cut interest rates again next month.
The Labor Department's closely watched monthly employment report on Friday came a day after President Donald Trump announced an additional 10% tariff on $300 billion worth of Chinese imports starting Sept. 1, a move that led financial markets to fully price in a rate cut in September.
The U.S. central bank on Wednesday cut its short-term interest rate for the first time since 2008. Fed Chairman Jerome Powell described the widely anticipated 25-basis-point monetary policy easing as insurance against downside risks to the 10-year old economic expansion, the longest in history, from trade tensions and slowing global growth.
"Fed officials don't exactly have mud in their eyes after cutting interest rates this week as job growth is slowing with the rest of the world," said Chris Rupkey, chief economist at MUFG in New York. "We see nothing in today's report to stop a second rate cut next month."
Nonfarm payrolls increased by 164,000 jobs last month, the government said. The economy created 41,000 fewer jobs in May and June than previously reported. July's job gains were in line with economists' expectations.
Underscoring the moderation in hiring, the average workweek fell to its lowest level in nearly two years in July as manufacturers cut hours for workers. Hours were also reduced in other industries, contributing to the workweek's drop to 34.3 hours, the fewest since September 2017, from 34.4 hours in June.
"The decline in hours worked suggests that employers may be pulling back more than headline hiring would suggest," said Andrew Schneider, a U.S. economist at BNP Paribas in New York.
A measure of hours worked, which is a proxy for gross domestic product, fell 0.2% in July, pointing to weak output.
The U.S.-China trade war is taking a toll on manufacturing, with production declining for two straight quarters. Business investment has also been hit, contracting in the second quarter for the first time in more than three years and helping to hold back the economy to a 2.1% annualized growth rate. The economy grew at a 3.1% pace in the first quarter.
The White House's "America First" policies are also restricting trade flows. A separate report from the Commerce Department on Friday showed sharp declines in both imports and exports in June, leading a 0.3% dip in the trade deficit to $55.2 billion during the month.
Job gains over the last three months averaged 140,000 per month, the fewest in nearly two years, compared to 223,000 in 2018. Economists say it is unclear whether the loss of momentum in hiring was due to ebbing demand for labor or a shortage of qualified workers.
Still, the pace of job gains remains well above the roughly 100,000 needed per month to keep up with growth in the working-age population. The unemployment rate was unchanged at 3.7% in July as 370,000 people entered the labor force.
Despite the lowest jobless rate in nearly 50 years, wage gains remain moderate, contributing to a tame inflation environment, which could be supportive of a rate cut at the Fed's Sept. 17-18 policy meeting.
Inflation has undershot the central bank's 2% target this year, rising 1.6% on a year-on-year basis in June after a 1.5% gain in May. Average hourly earnings rose 8 cents, or 0.3%, in July, after the same increase in June. That lifted the annual increase in wages to 3.2% in July from 3.1% in June.
Financial markets have fully priced in a rate cut in September and the chances for further easing in December have increased, according to CME Group's FedWatch tool.
The dollar was trading lower against a basket of currencies, while U.S. Treasury prices rose. Stocks on Wall Street tumbled to a one-month low.
Even with the step-down in employment growth and moderate wage gains, the labor market is supporting the economy as the stimulus from last year's $1.5 trillion tax cut package fades. The economy is expected to grow around 2.5% this year.
There was some encouraging news on the jobs market. The labor force participation rate, or the proportion of working-age Americans who have a job or are looking for one, rose to 63.0% in July from 62.9% in June.
A broader measure of unemployment, which includes people who want to work but have given up searching and those working part-time because they cannot find full-time employment, fell two-tenths of a percentage point to 7.0% last month, the lowest level since December 2000.
The moderation in hiring was led by construction, which increased payrolls by 4,000 jobs after creating 18,000 positions in June.
Manufacturing employment rose by 16,000 jobs after advancing by 12,000 in June. The strong gains are at odds with weak factory activity. A survey on Thursday showed manufacturing employment hit its lowest level since November 2016 in July.
The sector, which accounts for more than 12% of the U.S. economy, is also battling an inventory bulge and design problems at aerospace giant Boeing Co. The manufacturing workweek dropped 0.3 hour to 40.4 hours, the lowest since November 2011. Factory overtime fell by 0.2 hour to 3.2 hours.
"A prolonged drop in hours worked signals that businesses may reduce hiring, with layoffs and cutbacks in private spending to potentially follow, said Beth Ann Bovino, U.S. chief economist at S&P Global Ratings in New York.
Government employment increased by 16,000 jobs in July, boosted by local government hiring, adding to June's gain of 14,000. Professional and business services employment rose by 38,000 jobs last month.
There were also increases in healthcare, leisure and hospitality, financial activities and wholesale trade employment. But retail payrolls dropped by 3,600 jobs, declining for a sixth straight month.
Reporting by Lucia Mutikani Editing by Paul Simao