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* Nonfarm payrolls increase by 209,000 in July
* Unemployment rate falls to 4.3 percent
* Average hourly earnings increase 0.3 percent
By Lucia Mutikani
WASHINGTON, Aug 4 (Reuters) - U.S. employers hired more workers than expected in July and raised their wages, signs of labor market tightness that likely clears the way for the Federal Reserve to announce a plan to start shrinking its massive bond portfolio.
The Labor Department said on Friday that nonfarm payrolls increased by 209,000 jobs last month amid broad-based gains. June's employment gain was revised up to 231,000 from the previously reported 222,000.
Average hourly earnings increased nine cents, or 0.3 percent, in July after rising 0.2 percent in June. That was the biggest rise in five months. On a year-on-year basis, wages increased 2.5 percent for the fourth straight month.
"The Fed set a low bar for balance sheet normalization to begin in September, and today's number cleared that bar with elan," said Michael Feroli, economist at JPMorgan in New York.
Although the economy is near full employment, wage growth has not been strong in part because many of the jobs being created are in low-wage industries. Last month, restaurants and bars added 53,100 jobs.
July's monthly increase in earnings could, however, offer Fed policymakers some assurance that inflation will gradually rise to the U.S. central bank's 2 percent target.
Economists expect the Fed will announce a plan to start reducing its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities at its next policy meeting in September. The Fed bought these securities to lower interest rates in the wake of the 2007-2009 financial crisis.
Sluggish wage growth and the accompanying benign inflation, however, suggest the Fed will delay raising interest rates again until December. It has increased borrowing costs twice this year and its benchmark overnight interest rate is in a range of 1 percent to 1.25 percent.
The dollar rose and was set for its biggest one-day gain versus a basket of currencies this year, while prices for U.S. Treasuries fell. Stocks on Wall Street edged higher.
Economists had forecast payrolls increasing by 183,000 jobs and wages rising 0.3 percent in July.
Republican President Donald Trump, who inherited a strong job market from the Obama administration, cheered Friday's employment data. "Excellent Jobs Numbers just released - and I have only just begun," Trump said on Twitter. "Many job stifling regulations continue to fall. Movement back to USA!"
Trump has pledged to sharply boost economic growth and further strengthen the labor market by slashing taxes, cutting regulation and boosting infrastructure spending.
But after six months in office the Trump administration has failed to pass any economic legislation and has yet to articulate a plan for much of its economic agenda.
UNEMPLOYMENT RATE FALLS
Wage growth is crucial to sustaining the U.S. economic expansion after output increased at a 2.6 percent annual rate in the second quarter, an acceleration from the January-March period's pedestrian 1.2 percent pace.
The economy also got a boost from another report on Friday showing a sharp drop in the trade deficit in June.
The unemployment rate dropped one-tenth of a percentage point to 4.3 percent in July, matching a 16-year low touched in May. It has declined five-tenths of a percentage point this year and is now at the most recent Fed median forecast for 2017.
"Stable year-on-year wage growth should decrease the perceived risk of further slowing in wages and prices," said Andrew Hollenhorst, an economist at Citigroup in New York.
"Strong payroll gains that place downward pressure on the post-crisis low unemployment rate will keep the center of the Fed comfortable with increasing policy rates in December."
July's decline in the jobless rate came even as more people entered the labor force, underscoring job market strength.
The labor force participation rate, or the share of working-age Americans who are employed or at least looking for a job, rose one-tenth of a percentage point to 62.9 percent. The share of the population that is employed climbed to 60.2 percent, matching an eight-year high touched in April.
A broad measure of unemployment, which includes people who want to work but have given up searching and those working part time because they cannot find full-time employment, was unchanged at 8.6 percent last month. This alternative gauge of unemployment hit a 9-1/2-year low in May.
Monthly job growth this year has averaged 184,000, close to the 2016 average of 186,000. The economy needs to create 75,000 to 100,000 jobs per month just to keep up with growth in the working-age population.
Manufacturing payrolls advanced by 16,000 jobs in July, the largest gain since February. Employment in the automobile sector rose by 1,600 despite slowing sales and bloated inventories that have forced manufacturers to cut back on production.
U.S. auto sales fell 6.1 percent in July from a year ago to a seasonally adjusted rate of 16.73 million units. General Motors Co and Ford Motor Co have both said they will cut production in the second half of the year.
Construction payrolls rose 6,000 last month as hiring at homebuilding sites increased 5,100. The professional and business services sector added 49,000 workers last month.
Retail employment rose by 900 as hiring at motor vehicle and parts dealerships as well as online retailers offset a drop of 10,000 in employment at clothing stores.
Companies like major online retailer Amazon are creating jobs at warehouses and distribution centers. Amazon this week held a series of job fairs to hire about 50,000 workers. Government payrolls rose by 4,000 in July.
(Reporting by Lucia Mutikani; Editing by James Dalgleish and Paul Simao)