A sluggish U.S. economy added jobs at far slower pace than expected in March, keeping the door open for the Federal Reserve to provide further monetary support, even as the unemployment rate fell to a three-year low of 8.2 percent.

Employers added 120,000 jobs last month, the Labor Department said on Friday, the smallest increase since October and way below the lowest estimate in a Reuters survey. Economists had expected an increase of 203,000 and the jobless rate to hold at 8.3 percent.

The retail sector shed jobs for the second straight month, pulling down job growth in the massive service sector. Manufacturing jobs picked up a little but hours worked slipped.

The weak employment growth likely reflected the fading boost from unseasonably warm winter weather and brings the jobs market more in line with a broader slowdown in the overall economy.

Given that the report reflects only one month of data and some of the underlying cyclical sectors registered payroll gains, we do not view it as conclusively signalling a shift to a lower trend rate of employment growth, said Michael Gapen, a senior economist at Barclays in New York.

The soft employment numbers certainly leave the door open for further accommodation and may shift the decision point to the June meeting as the Fed continues to monitor the incoming data.

U.S. stocks slipped on the disappointing data, with S&P 500 stock index futures shedding 1.2 percent. The New York Stock Exchange is closed today for the Good Friday holiday. U.S. Treasury debt prices turned sharply higher, lowering yields on expectations that the report increases chances for more Federal Reserve bond buying. The dollar turned lower versus euro.

The jobs report backs the caution expressed by Fed Chairman Ben Bernanke last week that the labor market could sustain gains above the 200,000 mark when economic growth is tracking a sub-par rate. The economy is believed to have slowed in the first quarter to around a 2 percent annual rate from the 3 percent rate in the October-December period.

This is going to keep the Fed in easy policy mode. They're going to want to see a step toward 300,000 before they start to think about seeing a stronger outlook for the economy, said Sean Incremona, an economist at 4CAST in New York.

White House economic adviser Gene Sperling said the data showed the U.S. economy is making progress but still has a long way to go. Jobs are a key issue in President Barack Obama's re-election campaign.

Mitt Romney, his likely Republican opponent, called the report very troubling.

It is increasingly clear the Obama economy is not working and that after three years in office the President's excuses have run out, he said.

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US non-farm payrolls graphic: http://link.reuters.com/wej57s

Graphic on US unemployment: http://link.reuters.com/zej57s

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While the unemployment rate fell to its lowest level since January 2009, that was mainly because some people gave up the search for work. The separate household survey, from which the jobless rate is derived also showed a drop in employment.

The unemployment rate has fallen from 9.1 percent in August.

The weakness in hiring last month was concentrated in the vast private services sector, which added only 90,000 after increasing payrolls by 204,000 in February. Retail employment fell dropped 33,800 after falling 28,600 the prior month.

Construction hiring fell 7,000, the second straight monthly decline. Temporary help fell 7,500 after rising 54,900 in February.

However, manufacturing enjoyed another month of strong job gains, with factories adding 37,000 new positions, helped by carmakers trying to meet pent-up demand for motor vehicles. Factory jobs increased by 31,000 in February.

Government employment edged down 1,000 after rising 7,000 in February. Despite the weak employment gains last month, average hourly earnings rose 5 cents.

The workweek dipped to 34.5 hours from 34.6 hours in February.

(Reporting By Lucia Mutikani; Editing by Neil Stempleman)