U.S. Added 528,000 Jobs in July

The unemployment rate dropped to 3.5%, a half-century low also seen just before the pandemic in early 2020, the Labor Department said Friday.

The labor-force participation rate—or the share of adults working or seeking a job—ticked down to 62.1% in July from 62.2% a month earlier. While the economy has recovered all the jobs it lost since February 2020, there are still 623,000 fewer people in the workforce, a factor that has pushed up wages due to a demand for workers that is well above the number of available workers.

Wage growth was stronger than economists anticipated in July, with average hourly earnings rising 0.5% from June and 5.2% from a year ago. Wage growth in June was also revised higher, indicating that earlier data overstated the magnitude of a recent deceleration in the brisk pace of wage growth.

Job gains were widespread last month. Employers in leisure and hospitality added jobs at a solid clip, as restaurants and bars continued to recover. Payrolls also grew in healthcare and professional and business services, which includes many white-collar jobs.

Industries vulnerable to the Federal Reserve’s interest-rate increases also performed well in July. Construction firms, manufacturers and finance companies all added to payrolls.

By defying expectations of an economic slowdown, the report will make it harder for the Federal Reserve to dial back the pace of rate increases at its meeting next month. The behavior of wages is particularly important to the Fed right now because of concerns that companies are raising wages because they can pass higher labor costs on to consumers as a result of the current inflationary environment.

Stocks dropped when markets opened Friday after the report.

“We’re not in a recession yet,” said

Greg Daco,

chief economist at EY-Parthenon, a consulting firm. “From a Fed perspective, this report says, ‘let’s keep pressing on the policy brake’ because inflation is uncomfortably high.”

Businesses have continued to hire despite two straight quarters of economic contraction, cooling consumer spending and rising risks of a recession. Overall employment also has nearly returned to prepandemic levels. But demand for workers in some sectors is cooling as the economy transitions away from the red-hot expansion that followed the elimination of Covid-19-related restrictions on business activity.

Some companies such as

Walmart Inc.

and

Robinhood Markets Inc.

are cutting staff, but overall layoffs are slowly rising, according to weekly unemployment claims.

U.S. job openings remained elevated but fell in June to their lowest level in nine months and fell by 600,000 from May, according to a separate report from the Labor Department released Tuesday. Total job openings remained well above the number of unemployed workers looking for a job.

Federal Reserve officials are hopeful they can achieve a “soft landing” for the U.S. economy as they try to bring down the highest inflation in four decades without a major increase in unemployment. Fed Chairman

Jerome Powell

told reporters recently that the number of job openings could fall significantly without a big rise in unemployment.

So far, average weekly layoffs have ticked up only slightly, and anecdotal evidence suggests that they are primarily affecting sectors like technology and real estate, which are more sensitive to interest-rate increases. A number of tech companies, including

Microsoft Corp.

,

Meta Platforms Inc.

and

Netflix Inc.,

in recent months have laid off employees or stalled hiring to deal with slowing growth and fallout from other macroeconomic factors.

Demand for workers is still high in sectors that haven’t fully recovered from Covid-19, including leisure and hospitality, education and healthcare.

Matt Zebatto, chief executive of Life’s WORC, a nonprofit that runs group homes, job training and other programs for individuals with developmental disabilities in New York City and nearby counties, said that his agency’s staffing challenges are approaching crisis levels. Out of 730 positions for direct support professionals—employees who staff group homes round-the-clock—Mr. Zebatto is trying to fill more than 200.

The organization has been hamstrung by reimbursement rates from governmental healthcare programs such as Medicaid that haven’t kept up with prevailing wages in the labor market, hurting his ability to hire. In many areas, the rate is currently $15 an hour, and even with an expected inflation adjustment, the rate will remain under $16. Understaffing is a major issue, because of the level of care required by many group home residents. And when existing employees need to continuously work overtime shifts, it leads to more burnout and turnover.

“You can’t automate helping someone put on adult diapers or helping someone into a tub,” Mr. Zebatto said. “I’m grateful that someone who is working in the service industry is getting what they can get, but it makes it more difficult for us,” he said of the higher wages workers can earn working elsewhere.

Some economists expect more people to look for work as inflation weighs on household budgets.

Rapidly rising prices is the main reason older workers are unretiring, according to a survey by the jobs site

ZipRecruiter.

In the firm’s June survey, among the 21.5% of current job seekers who say that they previously retired at some point, 35.8% ranked inflation as the top reason that they have returned to the job market. Another 26.2% said that they are rejoining the workforce because they are running out of retirement savings.

Tess Devillier of Austin, Texas, took a job last month at a warehouse’s packaging and shipping department after working a series of retail, administrative and education jobs in recent years.

Her cost of living in Austin, a city that has seen rapid growth in recent years, has gone up. She needed to find a new job to be able to cite a source of income on an apartment application. She has also had conversations with a recruiter for substitute teachers and applied for a customer service position at a phone company, but decided to take the job at the warehouse because she could start almost immediately and resolve her housing situation.

“It doesn’t pay [as] much as I feel I should make, but I also don’t want to end up homeless,” she said of her new position.

More slack in the labor market will likely lead to workers having less leverage over hours, pay and benefits, economists say.

“We’re already seeing job-seeker confidence fall somewhat,” said

Julia Pollak,

chief economist at ZipRecruiter. “Just small movements for now, but the changes are all in the same direction: a fall in bargaining power and leverage.”

Write to Gabriel T. Rubin at gabriel.rubin@wsj.com