* U.S. job growth surges, wage growth remains tepid
* Rate-sensitive bank stocks gain
* Dow down 0.22%, S&P 500 down 0.26%, Nasdaq down 0.18% (Updates to mid-afternoon, changes byline)
By Chuck Mikolajczak
July 5 (Reuters) - U.S. stocks declined on Friday, as the S&P 500 retreated after closing at a record for three straight sessions, following an unexpectedly strong U.S. payrolls report that caused investors to rethink how dovish a turn the Federal Reserve may take.
The U.S. Labor Department data showed nonfarm payrolls rose by 224,000 jobs in June, the most in five months, and solidly beating economists' expectation of 160,000 additions.
Traders sharply scaled back their expectations of a rate cut of half a percentage point by the central bank at its next policy meeting on July 30-31, although confidence remained high the Fed would cut rates by 25 basis points.
Stocks slumped in May as trade talks between the U.S. and China were at a standstill and economic data began to point to a slowing. However, equities have rallied since June as the Fed and other global central banks signaled they were becoming more dovish.
"The thing right now is that markets don’t feel like we are in a good spot to get sustained, strong economic data as long as these tariffs are hanging over the market," said Shawn Cruz, manager of trader strategy at TD Ameritrade in Jersey City, New Jersey.
"So really your only hope, at least for the near term, is that the Fed remains accommodative and maybe even gets a little bit more accommodative until we get a resolution to a lot of the tariff and trade issues."
The Dow Jones Industrial Average fell 59.97 points, or 0.22%, to 26,906.03, the S&P 500 lost 7.76 points, or 0.26%, to 2,988.06 and the Nasdaq Composite dropped 14.44 points, or 0.18%, to 8,155.79.
Despite Friday's losses, major equity indexes were still on pace for solid weekly gains.
The jobs report also pointed to persistent moderate wage gains and mounting evidence that the economy was losing momentum, which could still give the Fed enough of a cushion to cut rates at the end of the month.
The Fed, in its semi-annual report to Congress, repeated its pledge to "act as appropriate" to sustain the economic expansion, and said while U.S. economic growth continued "at a solid pace" in the first half of the year it likely weakened in recent months as higher tariffs weighed.
Shares of banks, which have been under pressure from falling benchmark debt yields in recent weeks, rose 0.70% and helped drive a 0.32% gain in the financial sector, one of the few bright spots among S&P sectors.
The defensive names such as real estate, utilities and consumer staples - each declined as a rise in U.S. Treasury yields served to make the dividend-paying companies less attractive.
Trading volumes were light at the end of a holiday-shortened week as markets were shut on Thursday for the Independence Day holiday.
Declining issues outnumbered advancing ones on the NYSE by a 1.39-to-1 ratio; on Nasdaq, a 1.01-to-1 ratio favored decliners.
The S&P 500 posted 24 new 52-week highs and no new lows; the Nasdaq Composite recorded 46 new highs and 36 new lows. (Reporting by Chuck Mikolajczak Editing by Chizu Nomiyama)