U.S. job losses fell to their lowest level in a year last month, but the unemployment rate jumped to a 26-year high, painting a mixed picture of an economic recovery hindered by weakness in the labor market.

The Labor Department said on Friday the jobless rate climbed to 9.7 percent in August, the highest since June 1983. The bigger-than-expected rise suggested weak consumer spending would impede recovery from the worst slump in seven decades.

Employers cut 216,000 jobs, the smallest since August 2008, but the department revised upward the June and July job losses by 49,000.

Things are much better than they were six months ago, but the patient is still somewhat sick and on the road to recovery, said Jack Bauer, a senior economist at Manning & Napier in Rochester, New York. The recession ended probably somewhere around June, but the recovery is going to be muted.

The jobs report confirmed the pace of layoffs had eased from early this year. Nearly three-quarters of a million jobs were lost in January alone.

Analysts had expected non-farm employers to cut 225,000 workers from their payrolls in August and had looked for the unemployment rate to rise to only 9.5 percent after dipping to 9.4 percent in July.

U.S. stocks initially fell as investors focused on the surge in the unemployment rate, but reversed course to end higher for a second straight session as the focus turned to the smaller-than-expected decline in non-farm payrolls..

The trajectory is in the right direction, White House economic adviser Christina Romer said.

While the U.S. economy appears to have pulled out of the recession that began in December 2007, unemployment is expected to continue to mount for the next several months.

A Reuters survey showed most big banks that do business directly with the Federal Reserve expect the jobless rate to peak by the first quarter of 2010 and believe the U.S. central bank will start raising interest rates only next year.

Interest rate futures indicate the Fed is likely to push back the date it will begin raising benchmark interest rates from their current level near zero percent.

Finance leaders meeting in London agree on the need to keep economic life-support policies in place as they seek to nurse the global economy back to health, G7 sources told Reuters.

DISCOURAGED JOB SEEKERS RETURN

The U.S. unemployment rate in August was partially lifted by the return to the labor force of some jobless workers who had given up looking for work, but the main cause was a big drop in employment.

A gauge of labor market slack that measures both the officially unemployed and discouraged job seekers rose to a record 16.8 percent in August from 16.3 percent in July. The report showed about 5 million people had been unemployed for more than six months.

If you've been unemployed for a long time, it makes it harder to get a job, Charles Kramer, the International Monetary Fund's mission chief to the United States, told Reuters.

Since the start of the recession, the economy has shed 6.9 million jobs. The government has rolled out a $787 billion package of spending and tax cuts to rescue the economy.

The stimulus package has created or sustained 150,000 jobs in its first 100 days and would add 600,000 more during its second 100 days, Vice President Joe Biden has said.

MORE JOBS IN HEALTH, EDUCATION

Manufacturing employment fell 63,000 last month, pushing the total number of factory jobs lost since the start of the recession to 2 million. Construction industry payrolls dropped 65,000 after falling 73,000 in July.

The service-providing sector purged 80,000 workers in August, while goods-producing industries shed 136,000 positions. Education and health services added 52,000 jobs in August after increasing payrolls by 21,000 in July.

We are on track to break even on jobs by the end of the year and will be producing positive jobs growth in the first part of ... 2010, said Phil Orlando, chief equity market strategist at Federated Investors in New York.

Still, Orlando cautioned that consumer spending, which normally accounts for about two-thirds of U.S. economic activity, was likely to be sluggish for some time.

The consumer is going to lag. The pieces that are going to drive this recovery are strong overseas growth, the weak dollar and export growth, which is going to drive a sharp inventory growth commencing this quarter.

The length of the average workweek, which closely correlates with overall output and gives clues on when firms will start hiring, held steady at 33.1 hours in August.

Average hourly earnings rose to $18.65 in August from $18.59 in July.

(Additional reporting by Alister Bull and Lesley Wroughton in Washington, and John Parry in New York; Editing by Leslie Adler)

New York Unemployment