Hiring shifted into a higher gear in July, with the largest expansion of payrolls in three months. The unemployment rate held steady at 5 percent.

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WASHINGTON — Hiring shifted into a higher gear in July, with the largest expansion of payrolls in three months. The unemployment rate held steady at 5 percent.

The latest snapshot, released by the Labor Department today, offered strong evidence that the job climate is improving considerably, good news both for the overall economy and for those seeking work.

The 207,000 increase in payroll jobs last month reflected hiring across a range of industries. Retailing, education and health services, financial activities and construction all expanded employment. But factories shed jobs for the second month in a row.

“Businesses feel more confident about the economy,” said Mark Zandi, chief economist at Economy.com.

“I think the environment for jobseekers is steadily improving and is now good. I think there are increasing job opportunities across a wide spectrum of industries and occupations,” Zandi said. “I think the job market will improve further in the course of the coming year.”

Also encouraging to economists was that job growth in May and June proved stronger than previously thought. The number of jobs increased by 126,000 in May and 166,000 in June, according to revised figures.

So far this year, the economy is adding an average of 191,000 jobs a month. That is better than the average 183,000 a month registered last year.

On Wall Street, stocks were falling as stronger labor market conditions and a pickup in earnings heightened fears about inflation. The Dow Jones industrials lost 32 points and the Nasdaq was off 10 points in Friday morning trading.

The payroll performance in July exceeded economists’ expectations. They were predicting a gain of 180,000 positions. They expected the jobless rate to hold steady at 5 percent, a nearly four year low.

The employment increase in July was the most since the addition of 292,000 in April.

The department said Hurricane Dennis, which ripped through Florida, Alabama and Mississippi last month, had “no discernible” effect on job growth in July.

The Federal Reserve, which next meets Tuesday, is expected to raise short-term interest rates by one-quarter of a percentage point. It would be the 10th such increase since the central bank began to tighten credit on June 2004 to keep inflation in check.

With the labor market improving, the Fed is keeping close watch for signs of inflation, especially any from the compensation front.

Workers’ average hourly earnings rose to $16.13 in July. That was 0.4 percent more than the average in June of $16.07. The increase was the most in a year. That’s good for workers but was a bit worrisome to some economists who fret about inflation pressures picking up.

Economists pointed to the earnings increase as buttressing their belief that the Fed will continue to raise rates this year — and probably into 2006 — to prevent inflation from breaking out.

The labor market is the one part of the economy that has had difficulty getting back to full health after the 2001 recession.

But today’s report offered hope that the labor market recovery might stay in a higher gear. It also suggested that surging energy prices were not crimping employment.

Oil prices hit a closing hit of $61.28 a barrel in early July. On Wednesday prices briefly reached $62.50 a barrel before retreating. Gasoline prices are staying well above $2 a gallon.

President Bush wants to see both jobs and the economy on solid footing as he tries to sell his plan for overhauling the Depression-era Social Security retirement system.

The report also showed that the average time that the unemployed spent searching for work in July was 17.6 weeks, compared with 17.1 in June.