The pace of expansion in the manufacturing and service sectors quickened modestly in December, two upcoming surveys are expected to show, further evidence of an economy that is mending gradually.

The Institute for Supply Management, an industry group, will publish its two major monthly surveys next week. According to a Reuters poll of economists, ISM's high-profile measure of U.S. factory activity, due on Monday, should edge higher to 56.9 from 56.6. Readings above 50 point to growth.

A surge in Midwest factory activity reported in the Chicago purchasing managers survey this week to its highest level since 1988 has some economists on guard for possible surprises to the upside in ISM's national survey.

Separately, ISM's index of the vast U.S. services sector, slated for publication on Wednesday, is also seen rising marginally. The barometer, which covers a wide range of sectors ranging from airlines to restaurants, is projected to climb to 55.5 from 55.0.

The U.S. economy has grown in fits and starts since the worst recession in generations came to an end in the summer of 2009. Gross domestic product grew 2.5 percent in the third quarter, a level still considered too weak to put a meaningful dent in the nation's 9.8 percent jobless rate.

MARKET REACTION

Because both ISM surveys are not expected to show any drastic changes, market reaction will likely depend on just how far off the mark forecasts turn out to be. A sharper-than-expected rise could bolster stocks and hurt government bonds by renewing hopes for economic growth to pick up in 2011.

The reverse would be true if the numbers fall significantly short of estimates. The U.S. dollar will likely track bond yields, which move opposite to their price.

Following are comments from some economists on the two surveys:

JONATHAN BASILE, ECONOMIST, CREDIT SUISSE, NEW YORK:

The headline Chicago PMI and the forward-looking new orders index have both outperformed the ISM manufacturing index and ISM manufacturing new orders index, respectively, for the last six months. If the December Chicago report is any indication of the broader national trend, then ISM has some catching up to do.

BANK OF AMERICA-MERRILL LYNCH U.S. ECONOMICS TEAM:

The ISM manufacturing index is expected to rise to 57.5 in December from 56.6 in November. The manufacturing sector continues to outperform the broader economy. With equity markets rallying over the month, we suspect business sentiment has improved. The regional manufacturing surveys have, on net, improved and initial jobless claims dropped to fresh cycle lows as well. Our sense is that the economy picked up momentum as we closed out the year and we expect this to be reflected in the ISM.

The ISM non-manufacturing index is expected to improve to 56.0 in December from 55.0 in November. The only regional survey we have comes from the Richmond Fed District and its service sector index soared to +21 in December from +7 in November. On top of that, we know that we are closing the year with a strong holiday shopping season, consumer discretionary stocks are making new highs and jobless claims are breaking down to cycle lows. All of this bodes well for service sector sentiment across the country.

(Reporting by Pedro Nicolaci da Costa; Editing by Dan Grebler)

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