WASHINGTON (Reuters), Fri Nov 3, 5:10 PM ET  - The U.S. unemployment rate fell to a 5-1/2 year low in October and hiring in the two prior months was revised up, the government said on Friday, leading financial markets to slash bets on interest-rate cuts.

The rosier-than-expected job picture, days before next Tuesday's congressional elections in which ruling Republicans are considered at risk of losing control, caused rejoicing among President George W. Bush's party but Democrats countered that most Americans still say household budgets are under pressure.

The Labor Department said 92,000 jobs were added in October. But it said hiring in each of September and August was far more vigorous than first thought, implying enough economic vigor to keep growing despite a housing-industry slowdown.

September's job-creation total was revised up to 148,000, nearly three times the 51,000 reported a month ago, and there were 230,000 new jobs in August instead of 188,000.

The unemployment rate fell in October to 4.4 percent from 4.6 percent in September. It was the lowest jobless rate since 4.3 percent in May 2001.

Bond prices sank on fears it erased any chances of interest-rate reductions in the near future. The price of the benchmark 10-year U.S. Treasury notes fell 30/32 for a yield of 4.72 percent, compared with 4.60 percent late on Thursday.

Stocks also fell, partly on fears the Fed might need to raise rates to keep inflation risks in check if it the labor market becomes too tight. The Dow Jones industrial average fell 32.50 points to close at 11,986.04.

SERVICES EXPANDING

At midmorning, the Institute for Supply Management reported growth in the service sector, the nation's biggest source of employment, was strong in October. Service businesses like banks, restaurants and hotels account for 80 percent of total U.S. business activity.

The private-sector group said its monthly services index climbed to 57.1 last month from 52.9 in September. Any measure over 50 signals the sector is expanding.

On a campaign swing in Springfield, Missouri, Bush cited the jobs figures as a reason to vote Republican in elections for the U.S. House of Representatives and for one-third of the Senate on Tuesday.

"Tax cuts have led to a strong and growing economy, and this morning we got more proof of that," Bush said. But Democratic Sen. Jack Reed (news, bio, voting record) of Rhode Island, the ranking Democrat on the Joint Economic Committee, said "staying the course on the President's policies has failed" to relieve average Americans' strained finances.

Analysts said the jobs data adds to confusion about the economy's direction, since it comes just a week after the government reported the weakest expansion in more than three years in the third quarter. Gross domestic product slowed to a 1.6 percent annual rate of growth from 2.6 percent in the second quarter.

EARNINGS UP

Notwithstanding softer overall growth, the Labor Department said average hourly earnings in October rose 0.4 percent to $16.91 -- higher than the 0.3 percent that analysts had anticipated -- while the average workweek edged up to 33.9 hours from 33.8. Over the year, average hourly earnings have risen by 3.9 percent, the department said.

The combination of slower growth and rising wages has to be unsettling for economic policy-makers, analysts said.

"The Fed would have liked the unemployment rate to jump 0.2 percentage point and payrolls to have been revised downward," said economist Joel Naroff of Naroff Economic Advisors in Holland, Pennsylvania. "They got the worst of all worlds and any thoughts of a near-term rate cut should be out the window."

Hugh Johnson, chief investment officer for Johnson Illington Advisors in Albany, New York, said the report underlined a tightening labor market that could mean future rate hikes instead of reductions.

"There's tightness showing up in the decline in the unemployment rate and in the upward pressure on wages, which were stronger than expected," Johnson said. "This will certainly give hawks on the Federal Open Market Committee some ammunition."

The payroll report is calculated from two separate surveys of households and businesses. The household survey showed that a whopping 437,000 more people were employed in October.

The business survey showed most of the new hiring in October was in service industries, where 152,000 new jobs were created, while goods-producing industries shed 60,000 jobs.