U.S. employment fell for a third straight month in August, but the drop was far less than expected and private hiring surprised on the upside, easing pressure on the Federal Reserve to prop up economic growth.

Nonfarm payrolls declined 54,000, the Labor Department said on Friday, helping to assuage fears of a double-dip recession. Financial markets had looked for a drop of 100,000 jobs.

However, the data will likely do little to take the political heat off President Barack Obama over his handling of the economy or improve the Democratic Party's chances in November's mid-term congressional elections.

It is inconsistent with fears that a sharp slowdown in the economy is under way. This report, together with other recent data, will convince the Fed to refrain from launching a new asset purchase program at this month's meeting, said Dean Maki, chief U.S. economist at Barclays Capital in New York.

The fall in payrolls last month was largely a result of 114,000 temporary census workers being laid off.

Private employment, considered a better gauge of labor market health, increased 67,000 after a revised 107,000 gain in July. Markets had expected a rise of only 41,000 in August.

In addition, the government revised payrolls for June and July to show 123,000 fewer jobs lost than previously reported.

Stocks on Wall Street rose on the data, but gains were capped by a separate report showing the dominant services sector grew much slower than expected in August.

The Institute for Supply Management's index of national services activity fell to 51.5 from 54.3 in July. That was below market expectations for 53.5.

Prices for safe-haven U.S. government debt fell sharply, however, as traders saw the odds of growth contracting lessening. The dollar rallied against the yen and euro.

Concerns of a double-dip recession had already diminished somewhat this week as data showed strength in manufacturing and gains in consumer spending, but the sluggish pace of growth has kept investors on edge.

Last month, the unemployment rate edged up to 9.6 percent, in line with market expectations, as discouraged workers came back into the labor force to hunt for jobs.

CONSUMER SPENDING HURT

Jobs scarcity has hurt consumer spending, which normally accounts for about two-thirds of U.S. economic activity, and left the recovery from the worst recession in 70 years sputtering.

Growth slowed markedly in the second quarter this year and Fed Chairman Ben Bernanke said last week the central bank stood ready to take fresh measures to support the economy if needed.

The economy's poor health has weakened Obama's popularity and could see Republicans wrestle control of Congress away from the Democratic Party in November.

Obama welcomed the report as positive news and told reporters he would address a broader package of ideas to help spur the economy next week.

The economy is moving in a positive direction, jobs are being created -- they're just not being created as fast as they need to given the big hole that we experienced, he said, as he called on Congress to pass a small business lending bill.

While the jobs data cheered markets, Republicans cited it as a sign that policies pushed by Democrats had failed.

We need a Congress and a White House that will listen to the American people, who are asking 'where are the jobs?,' and help end the uncertainty for small businesses, House Republican leader John Boehner said in a statement.

Typically in midterm elections when there is no presidential race the party in power in the White House suffers losses, but analysts say the drubbing Democrats could face may be unusually severe.

Last month, the dominant service sector added 67,000 jobs after July's 70,000 rise. Temporary help services, which is seen as a harbinger of future permanent hiring, rebounded 16,800 after falling in July for the first time since September.

There were more job losses at cash-strapped state governments, helping to pull down government payrolls by 121,000 compared to a 161,000 fall in July.

Employment in the goods-producing sector was unchanged last month as a drop in manufacturing offset an increase in construction payrolls, which were boosted by the return of 10,000 striking workers. Manufacturing jobs fell 27,000 after gaining 34,000 in July.

The average workweek was unchanged at 34.2 hours the previous month.

(Editing by Tim Ahmann)

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