Growth in the U.S. services sector in January was the fastest in more than five years, another sign the economy started the new year on a solid footing, with measures of employment showing some strength.

While reports on Thursday continued to paint a bullish picture for the economy, they also showed some inflation pressures under control, in stark contrast to developments in other parts of the world. U.S. companies continue to hold the line on costs, despite a spike in commodity prices.

The Institute for Supply Management's index of national non-manufacturing activity rose to 59.4 last month -- above economists' expectations for dip to 57.0 -- from 57.1 in December.

A reading below 50 indicates contraction in the sector, and it was the 14th straight month of expansion in the nation's vast services sector.

The economic data continue to overshoot expectations. We are seeing an acceleration in economic activity that is less reliant on public support and more self-sustaining, said Scott Anderson a senior economist at Wells Fargo Securities in , Minneapolis.

The economy grew at a 3.2 percent annual rate in the fourth quarter, accelerating from a 2.6 percent pace in the prior period, and economists believe strengthening domestic demand will translate into increased hiring of new workers.

A report from the Labor Department showed initial claims for state unemployment benefits tumbled 42,000 to a seasonally adjusted 415,000, unwinding most of the previous week's weather-induced spike.

Economists had forecast claims dropping to 420,000.

The claims data falls outside the survey period for the government's closely watched employment report for January, scheduled for release on Friday.

The economy probably created 145,000 jobs, according to a Reuters poll, after adding 103,000 in December. Reports on Wednesday suggested private hiring was gathering pace.

JOBS OUTLOOK IMPROVING

Expectations for a rise a pick-up in jobs growth last month were also bolstered by a jump in the ISM's employment gauge to the highest level since May 2006.

The data had little impact on U.S. financial markets as stock market investors worried about increasing chaos in Egypt. U.S. stocks fell and prices for government debt also traded lower. The dollar rose against a basket of currencies.

Though the downward trend in initial claims has been slowed by extreme weather in large parts of the country, economists believe they will soon drop below 400,000, a level believed to signal strong job growth.

We think the trend in claims is coming down because small firms are firing fewer people. With credit now easing we are hopeful claims will fall significantly further over the next few months, said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York.

A second report from the Labor Department showed that while businesses were facing rising input costs, they keeping labor costs down by squeezing more output from workers, helping to keep inflation muted.

Nonfarm productivity, a measure of hourly output per worker, increased at an annual rate of 2.6 percent, after rising at an upwardly revised 2.4 percent growth pace.

The increase, which was well above economists' expectations for a 2 percent growth rate, bodes well for company profits.

Unit labor costs, a gauge of potential inflation pressures closely watched by the Federal Reserve, fell at a 0.6 percent rate after dipping at a 0.1 percent pace in the third quarter.

Economists had expected unit labor costs to rise at a 0.3 percent rate in the fourth quarter. For the whole of 2010, unit labor costs dropped 1.5 percent after declining 1.6 percent in 2009.

Total nonfarm output grew at a 4.5 percent rate in the last three months of 2010, the Labor Department said, after rising at a revised 3.8 percent rate in the third quarter.

(Editing by Neil Stempleman)

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