Byline: TIM AHMANN

WASHINGTON, Aug. 7 (Reuters) US job growth picked up last month as employers added 207,000 workers to their payrolls, a healthy gain that led Wall Street to increase bets on more rate rises from the Federal Reserve.

The Labor Departments July employment report

"This is a crystal clear indication that the labor markets are very healthy and it reinforces the notion that the economy is growing in a healthy, sustainable way," said Dana Johnson, chief economist at Comerica in Detroit.

The Fed, which has raised the benchmark overnight lending rate at each of its last nine meetings, is widely expected to bump it up another quarter-percentage point to 3.5 percent when officials gather on Tuesday.

Financial markets see rates at 4 percent by year end. But Julys solid employment growth, which was driven by the service sector and outstripped Wall Street forecasts for 183,000 new jobs, led some to bet they could move even higher.

"The Fed is going to keep chugging along," said Robert MacIntosh, chief economist at Eaton Vance Management in Boston.

All 22 banks that deal directly with the Fed saw a quarter-point rise next week, according to a Reuters poll conducted after the jobs data. Only two anticipated a pause in September. In a late-June survey, eight thought the Fed might hold steady in September.

Prices for US government bonds tumbled on expectations of more rate rises, with yields surging to their highest level since mid-April. The dollar posted broad-based gains while US stocks fell on worries about higher rates.

If the rise in long-term borrowing costs proves lasting, it could spell trouble for indebted consumers.

A Fed report issued later on Friday showed US consumer credit rose an unexpectedly large $14.51 billion in June, the biggest jump in eight months, as both credit card use and closed-end lending surged.

The Bush administration hailed the employment report as a sign of the economys vigor. "This shows that the fundamentals of our economy are strong and that we are continuing on a positive path of growth and prosperity," US Treasury Secretary John Snow said in a statement.

While some economists thought the jobs data might be skewed by Hurricane Dennis, which battered the Florida panhandle in mid-July, the department said the storm appeared to have no discernible impact on the figures.

An upward revision of 42,000 to the combined job count for May and June contributed to the reports solid tenor. The new data showed 166,000 workers added in June and 126,000 in May.

The stronger job growth last month pushed this years average monthly payroll gain to 191,000, a pace economists see as strong enough to slowly tighten the labor market.

The factory sector, which shed 4,000 workers last month, was one of the only weak spots. However, the Labor Department noted that an 11,000-job drop in auto manufacturing reflected larger-than-normal temporary plant shutdowns for retooling.

The report was the latest in a string of strong data and the last significant piece of economic news before Fed policy-makers meet next week.

Average hourly earnings shot up six cents, or 0.4 percent, in July the biggest rise in a year. However, earnings are up just 2.7 percent over the past 12 months, suggesting wages have yet to become a big inflationary concern.

"As far as the Fed is concerned, payrolls growth is probably just about right not too hot and not too cold," Paul Ashworth of Capital Economics told clients in a research note.

Job growth was tepid at construction firms, which brought on just 7,000 new workers, but was strong on the service side of the economy.

Retailers added 50,000 workers, the biggest gain in that sector since April 2000. The strong retail hiring in part reflected growth at automobile dealers coping with a surge of shoppers enticed by special sales incentives.

Professional and business service firms, education and health service employers and the leisure and hospitality industry all exhibited robust hiring.

In another spot of bright economic news, the independent Economic Cycle Research Institute said on Friday its leading index of the US economy rose to a 12-week high last week.

ECRI said the index suggested prospects for US economic growth were improving gradually.