Jobs growth skidded to a near-halt in December and the unemployment rate hit a two-year high, according to a government report on Friday that raised recession fears and chances of more interest-rate cuts.

The Labor Department said only 18,000 new non-farm jobs were added last month, the weakest performance since August 2003, while the jobless rate jumped to 5 percent from 4.7 percent in November -- the largest monthly rise since October 2001 in the wake of the September 11 terror attacks.

The unemployment rate moved up in a shocking way and that's sort of political dynamite that may make the Fed more prone to easing than otherwise, said Pierre Ellis, senior economist at Decision Economics in New York.

Ellis said the U.S. central bank was more likely now to cut rates by a half percentage point than a quarter to add stimulus to a clearly flagging economy when it meets at month's end.

The data rattled financial markets already fearful about rising recession risks. Stock prices were sharply lower at midday, with the Dow Jones industrial average .DJI down about 200 points in early afternoon. The dollar's value fell and government bond prices soared.

EYES ON THE FED

There was a consensus of opinion that the Fed will have to keep cutting interest rates in a bid to rescue the economy from the continuing drag from a depressed housing sector and an unusual reluctance on the part of financial institutions to lend.

The central bank's policy-setting committee meets on January 29-30. It already has cut its benchmark federal funds rate 1 full percentage point since mid-September.

Bush administration officials hit the television circuit to press their case that it was not unusual for the pace of job creation to slow after a protracted period of growth.

It's just tougher to get high (jobs) growth when you're at the mature stage of a business cycle and that's where we are now, White House Council of Economic Advisers Chairman Edward Lazear said on CNBC television.

That doesn't mean that it's going to stop but it does mean that job growth is going to be slower than we saw over the past few years or so, Lazear added.

President George W. Bush, who told Reuters on Thursday he is considering a stimulus package for the struggling economy, was scheduled to meet top financial officials, including Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, on Friday to get an update on strains in credit markets.

A report at mid-morning from the Institute for Supply Management, showing its services index fell slightly to 53.9 in December from 54.1 in November, took some sting out of the jobs figure -- if only because the fall was not as large as feared.

The jobs report, however, fell far short of the already low expectations on Wall Street, where economists had looked for a 70,000 non-farm jobs gain.

FACTORY SECTOR SHRINKS

All the job growth in December came from government hiring, while private industry posted a 13,000 job loss, the first contractions in private-sector employment in nearly 4-1/2 years.

For all of 2007, payroll employment growth averaged 111,000 a month, down from 189,000 a month in 2006.

During December, manufacturing industries shed 31,000 jobs and construction businesses cut another 49,000. There were 31,000 more government jobs and 44,000 were added in education and health services, but retail industries cut more than 24,000 jobs.

Rick Meckler, president of Libertyview Capital Management in Jersey City, New Jersey, said the Fed now will be forced to cut rates even if some members fear it might fan inflation.

The risk to the Fed has always been between growth and inflation, and this seems to tip the scale toward sustaining growth and worrying about inflation another day, Meckler said. It makes rate cuts not only likely but extends them.

Weekly hours of work were unchanged at 33.8 in December. The factory workweek contracted to 41.1 hours from 41.3, and overtime hours dropped to 3.9 from 4.1 in November.

Richard Yamarone, chief economist for Argus Research in New York, said the soft jobs numbers apparently reflect a skittish attitude among businesses about hiring when the economy's prospects are doubtful.

But he noted that harsh winter weather may also have played a role in the weaker-than-expected December jobs picture. Most of the nation was iced over, Yamarone said.

(Additional reporting by Steven C. Johnson, Al Yoon and Herb Lash in New York; Editing by Andrea Ricci)

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