* May payrolls increase by 280,000 vs est 225,000
* Average hourly earnings increase
* Traders betting Fed will start raising rates in Oct
* Indexes: Dow down 0.18 pct, S&P down 0.06 pct, Nasdaq up 0.03 pct (Updates to early afternoon)
By Tanya Agrawal
June 5 (Reuters) - U.S. stocks were mixed in choppy trading on Friday as a stronger-than-expected May jobs report strengthened the view that the U.S. Federal Reserve will raise rates as early as September.
The strong jobs data indicated that economic growth was gaining traction after coming to a standstill in the first quarter, but Wall Street took a dim view as a rate hike could increase the cost of borrowing.
Traders are now betting the Fed will start raising interest rates as soon as October, and will make a second increase early next year.
"The market is addicted to the Fed's liquidity, and this certainly puts more ammunition in the Fed's plan to start lift-off in September," said Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia.
"It makes sense that the market would fall off on that, but this is good news."
The Fed has kept overnight rates near zero since December 2008 and the economy's sluggishness had raised doubts the Fed would be able to raise rates this year.
The International Monetary Fund cut its U.S. growth forecast on Thursday and urged the Fed to delay raising rates until 2016.
Bolstered by cheap credit, the U.S. stock market is trading at record levels but has stayed within a narrow trading range as investors look for more clarity on the economy.
Nonfarm payrolls increased by 280,000 last month, the biggest gain since December, and above the 225,000 that economists polled by Reuters had expected.
Average hourly earnings grew by eight cents, while unemployment rate inched up to 5.5 percent from 5.4 percent as more people were added to the labor market.
The dollar extended gains against a basket of currencies after the jobs data, while yields on 10-year U.S. Treasuries surged to their highest since October, before retreating.
New York Fed President William Dudley said he was concerned the economy may not be growing fast enough to absorb the slack left among workers sidelined by the financial crisis.
Still, Dudley said he expects the Fed would be in a position to raise rates later this year.
At 12:51 p.m. ET (1651 GMT) the Dow Jones industrial average was down 32.3 points, or 0.18 percent, at 17,873.28, the S&P 500 was down 1.3 points, or 0.06 percent, at 2,094.54 and the Nasdaq Composite was up 1.77 points, or 0.03 percent, at 5,060.89.
Eight of the 10 major S&P 500 sectors were lower, with the teleservices index leading the losses with a 1.6 percent drop. Both AT&T and Verizon fell about 1.5 percent.
Energy and financials were the only sectors in positive territory. JPMorgan Chase and Bank of America provided the biggest boost to the S&P 500.
Zumiez dropped 19.8 percent to $23.86 as it estimated current-quarter profit and revenue below analysts' expectations.
Declining issues outnumbered the advancers on the NYSE by 1,760 to 1,224, for a 1.44-to-1 ratio on the downside. On the Nasdaq, 1,381 issues rose and 1,264 fell for a 1.09-to-1 ratio favoring advancers.
The S&P 500 showed 16 new 52-week highs and six new lows while the Nasdaq recorded 72 new highs and 38 new lows. (Editing by Saumyadeb Chakrabarty)